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Stagonomics Weekly Market Recap By Brendan Callow Updated Sunday, February 2, 2020

The coronavirus continues to dominate the financial news despite a rather busy week which included a number of earnings reports, the FOMC’s policy meeting, as well as the quarterly release of the United States Gross Domestic Product. At the beginning of this month, we felt very optimistic about the prospects for a rebound in economic growth around the world. However, the ongoing developments related to the coronavirus have caused us to reevaluate

our thesis and explore the soundness of the current economic environment in order to determine whether the global economy, in its current state, could withstand a significant economic shock. After extensive research, including the evaluation of the economic data released this week, we have concluded that if the coronavirus continues to spread with such rapidity, the global economy could significantly suffer. The coronavirus continues to dominate headlines, causing investors around the world to become skittish. This change in investor sentiment was reflected in the price action of the major indices, as the S&P500, the DJIA, and the NASDAQ all experienced significant selling pressure. The details of this virus are still not entirely clear, however, as the situation develops and other countries are affected by the virus, the economic consequences will become more apparent. Despite the lack of concrete information, the market seems to be discounting a significant economic hiccup in the impending future. This has been demonstrated by the recent advance in safe haven assets such as Gold and Treasury Bonds, which have been aggressively bought over the past week. The recent pursuit of safe haven assets has caused another inversion of the yield curve, as yields on long term bonds have dipped below those of short term bills. This is the second time in the past year that the yield curve has inverted – a phenomenon that typically predicates a recession. Yield curve inversions however do not indicate the imminence of a recession, but rather indicate that there will be recessionary risk over the course of the coming year, as yield curve inversions are indicators whose predictive ability is greater over a longer period of time. The timing of this recent inversion is significant, as it occurred just as the FOMC declared in their policy meeting that the Federal Funds Rate will be held steady over the course of 2020.

This yield curve inversion could undermine this conclusion made by the FOMC at its recent policy meeting, as it is likely that they would need to further cut rates, as they did last year, if this yield curve inversion is sustained over a relatively long period of time. It is our belief that such a move by the Federal Reserve will severely undermine the Fed’s credibility, as further reducing rates after explicitly saying otherwise will cause equity markets to believe that the Fed will be continually accommodative throughout 2020, therefore allowing for sustained advances in equity markets despite a deteriorating economic backdrop. Amongst all of these developments that emerged over the course of this week, the Bureau of Economic Analysis released their data relating to the growth of the United States Gross Domestic Product. According to the BEA, the United States GDP increased 2.1% over the course of the fourth quarter. However, after examining the underlying contributors to this 2.1% growth in GDP, one can identify weakness in sectors that have provided strength to the economy in recent months. One worrisome part of the recent GDP report was the sluggish growth in Personal Consumption Expenditures over the course of the fourth quarter. In the past year, consumers have been essential in maintaining economic growth, as they have continually benefited from a tight labor market, which has allowed them to spend. Other reasons for the strength of the consumer include the Tax Cuts and Job Acts of 2017, which decreased consumer’s tax liabilities, allowing them to allocate more money to spending on goods and services. However, the most recent GDP data has shown that the effects of this tax cut have begun to fade, as consumers are less willing to spend relative to previous quarters. Personal Consumption Expenditures grew 1.8% over the course of the fourth quarter, falling below the average growth of the Personal Consumption Expenditures since 2016 by 100 bps. This

slowdown in consumer spending is a cause for concern, especially when considering the unpredictability of the coronavirus and its effect on the psyche of consumers. As a result of these developments highlighting the current economic environment, we should be extremely careful in navigating the financial markets, as a significant slowdown in consumer spending could have very negative effects on the economy as a whole. Developing fears related to the recent coronavirus outbreak caused significant selling pressure in equity markets over the course of this week. The S&P500 slid 2.12% on fears of the coronavirus. Similarly, the DJIA contracted 2.53%. As investors began to question the future economic environment, safe haven assets rallied. For example, the yield on the 10 year US Treasury note – which moves in the opposite direction of prices – slid about 20 bps over the course of this week to 1.509%.

Aggregate % change from the previous quarter of all contributors to GDP 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q4 Q3 Q4 Q2 Q3 Q1 Q4 Q2 Q3 16 16 16 16 17 17 17 17 18 18 18 19 19 18 19 19 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

Here is the aggregate change in all of the contributors of GDP when compared to the previous quarter. As you can see, although the face value of this GDP report was rather good, the weakness in the underlying components were a cause for concern.

The Fed has continually provided liquidity into the financial system in order to revive economic growth, however, this strategy has failed as money has not changed hands with enough ferocity as the Fed might have hoped it would....