What’s Priced In as Markets Are Positioned for a U.S. Recession
(Bloomberg) -- World markets have just had their most volatile week since the financial crisis of 2008. Many assumptions have been changed. So as the week ended, what exactly had markets priced in?
A Recession in the U.S.
Bloomberg’s own recession-probability indicator, based on signals from the yield curve, shifted to show a better than 50% chance of an economic slump within the next 12 months as of the end of February. With bonds far outperforming stocks since then, it is clear that the markets now are positioned for a recession in the U.S. this year.
An Oil Shock
The crude-oil price has halved since the first week of January, when tension with Iran briefly aroused fears that it would rise. It appears to be settling at the current price of just over $30. Unlike the last negative oil shock in late 2014, this time the energy companies have fallen as much as the oil price — a serious negative impact on the energy sector has been priced in.
A 100-bps Rate Cut by the Fed
Bloomberg’s World Interest Rate Probabilities function indicates a virtual certainty the Federal Reserve will slash the overnight fed funds rate by a full percentage point at its meeting next week, effectively bringing it back to zero. Chances the rate will rise from there in the next 12 months are perceived to be minimal.
Deflation Across the Developed World
Ten-year bond-market inflation breakevens show the market is braced for a protracted dose of very sluggish growth. This is true even by the standards of Japan and Germany, which have been wrestling with low growth for years. Japan’s inflation expectations have gone negative, U.S. inflation expectations are below 1% for the first time in more than a decade and German inflation expectations are also at a low for the decade, below 0.5%.
An Earnings Recession
The fall in price/earnings multiples confirms the evidence from broker research that investors now are positioned for a sharp fall in corporate earnings in both the U.S. and the rest of the world during the next few quarters. P/Es in the U.S. remain much higher than in the rest of the world and higher than they were in the first half of the last decade.
Trouble for Emerging Markets
The emerging world has taken the greatest strain over the last week. JPMorgan’s broad index of emerging-markets currencies has dropped to the lowest compared with the dollar since inception in 2010, and its widely followed EMBI spread of EM credit compared with the developed world has risen to its highest level since the Chinese devaluation crisis of 2015-2016.
Pressure on U.S. Balance Sheets
Small-company equity and high-yield bonds both sold off sharply in the last week, reflecting concerns that smaller businesses have become over-leveraged, particularly in the energy sector. High-yield bonds remain above their lows from the Christmas Eve sell-off of 2018.
Confidence in the FAANGs
There has been no reappraisal of the biggest internet stocks, which have outpaced the market for several years now. Both Apple and Microsoft retain market values of more than $1 trillion, while the so-called FAANG sector as a whole has performed in line with the market during the turbulence.
©2020 Bloomberg L.P.