Watch the Q&A
I’m Kevin Barr, Head of SEI’s Investment Management Unit. Joining me once again is Jim Smigiel, our CIO of Nontraditional Strategies and Head of our Asset Allocation team.
Thank you for joining me Jim. Can you start by commenting on the unusual action from the Federal Reserve?
Sure, as our viewers know by now, the Fed took the highly unusual step of announcing a 100 basis point rate cut last weekend, bringing the Fed Funds rate to the zero bound and announcing a $700 billion quantitative easing program including Treasuries and mortgage-backed securities.
Furthermore, on Monday the Fed came into the overnight lending market twice, pumping $1 trillion in to support loan capacity. While this area of the market may be unfamiliar to some investors, it’s a crucial lending market and the Fed’s effort was their latest attempt to address the burgeoning liquidity crisis.
The market didn’t react in a positive manner.
That is certainly true. As we spoke about last time, the main role for the Fed and all central banks at this point is to maintain liquid markets as much as they can. I say that because now that we are at the zero bound, and below in many countries, rate cuts will do little at this point. The good news is that the Fed is aware and is willing to take decisive action, which the $1 trillion in repo highlights. They now need to address the issues we are seeing in credit markets, specifically in the commercial paper short-term funding markets.
They’ve done that once before.
That’s right. During the global financial crisis, the Fed established the CPFF, or Commercial Paper Funding Facility, to address these same issues we saw back then, and I think the market was disappointed to not have that part of the Fed’s bazooka this time around. Essentially investors became reluctant to lend to corporations even on a short term basis. So for those companies that rely a bit too heavily on short-term financing, the risk of default was elevated. Back then the Fed stepped in a purchased 3- month commercial paper both asset backed and unsecured to alleviate this short-term strike from lenders. I would be surprised if we don’t hear more about this in the coming days which would be a welcome move and one that would be much better received than the 100 basis point rate cut.
So outside of that potential move from the Fed, the focus is really on the fiscal side of things here…
That’s exactly right. And that will come in several different forms. The first is the safety net type programs that were seeing out of the house bill which has President Trump’s support. Extending unemployment benefits, free testing, emergency sick leave things along those lines. These are really important issues and we should all be happy to see them working through the system. The next two types we expect to see on the horizon are specific support for certain industries…there’s already been talk of a $50 billion bailout for the airlines for instance, and then broad-based stimulus which could take the form of direct payments or federal tax holidays for individual and corporations. The challenges here are really the timing factor. These things take time to get through the red tape and while there’s nothing like a raging bear market to grease the wheels, in Washington these things cannot be done overnight.
Is the market reacting to that timeline?
I think the market continues to discount what seems to be an ever-expanding window of economic dislocation. The CDC came out with an 8-week ban recommendation for large gatherings. The President mentioned the summer months during the press conference and certain cities have announced more severe lockdowns. So, while I think most investors would agree that this is a temporary disruption, the market still has to guess HOW temporary. Clarity on that is only going to come with time, however, the three main categories of tools at our disposal all have the same game plan at this point. Whether we’re are talking about monetary policy, fiscal policy or social policy, the idea is the same; go big and go early. From a social standpoint, the distancing strategies we are seeing will have a seriously negative economic impact but, more importantly, also a seriously disruptive impact on transmission of the virus. What we are all collectively doing now will shorten that timeframe that the market is trying to discount. The monetary policy moves already put in place and those we expect to come as early as this week will help temper the liquidity issues in several parts of the market and all of these things will buy time to unleash the targeted and broad based fiscal response which is the most effective type of stimulus but unfortunately also the most time constrained to implement, but we should all understand, the fiscal side is coming. Washington is getting that message loud and clear. There is a massive amount of fiscal capacity that can be unleashed thatcan have a tremendous multiplier effect on the economy.
Jim we have heard talk of the potential closing of stock markets…what’s your take there?
That’s definitely a narrative that’s been floating around. We do not think that will happen and certainly do not think that it should happen. Price discovery, however difficult or painful it may be, is extremely important. In our view removing that ability will do nothing but cause undue panic for investors and actually increase the level of uncertainty in the market. Many bourses around the globe have circuit breakers to allow for buyers and sellers to catch their breath and some even have bans on short selling. These are appropriate ways to manage imbalances in order flow and are much more preferable than shuttering exchanges. We do not see that happening.
These last few days have been extremely volatile…what are we doing in response?
The volatility is as severe as we’ve seen. In fact the VIX closed Monday at the highest level on record, eclipsing the previously record from November of 2008. In addition this is by FAR the fastest bear market in history, as this 20% peak to trough decline occurred in 21 days. At a portfolio level we continue to encourage investors to stay diversified and avoid short-term trading during these volatile days. Our active managers are assessing the situations in real time and will adjust exposures accordingly and within their mandates. It is important to note that these potential adjustments include ways to both mitigate risk AND take advantage of the opportunities this dislocation is creating. This dual approach is warranted in our view given that we believe that any approach to fiscal stimulus will be large in scale and scope and will be priced in very quickly.
Glossary of terms:
- Basis Point: One basis point is equal to 1/100th of 1%.
- Bear Market: A bear market is a condition in which a security, market, or index’s price falls 20% or more from recent highs amid widespread pessimism and negative investor sentiment.
- The CBOE Volatility Index: The CBOE Volatility Index (VIX) is a measure of expected price fluctuations in the S&P 500 Index options over the next 30 days. The VIX, often termed as the "fear index," is calculated in real time by the Chicago Board Options Exchange (CBOE).
- Commercial Paper: The market for commercial paper, or debt that matures in 270 days or less, is used by highly-rated corporations to fund short-term liabilities, including inventory payments and employee salaries and therefore represents access to funds that businesses rely upon for basic operations.
- Overnight Market: The overnight market is the component of the money market involving the shortest term loan. Lenders agree to lend borrowers funds only "overnight" i.e. the borrower must repay the borrowed funds plus interest at the start of business the next day.
- Quantitative Easing: Quantitative easing is a monetary policy whereby a central bank buys predetermined amounts of government bonds or other financial assets in order to add money directly into the economy.
- Repurchase Market (Repo): “Repo” is the market for repurchase agreements. Repurchase agreements are collateralized short-term loans. One party sells to another and agrees to repurchase those securities later at a higher price. The securities serve as collateral. The difference between the securities’ initial price and their repurchase price is the interest paid on the loan, known as the repo rate.
- Short Selling: Short selling occurs when an investor borrows a security and sells it on the open market, planning to buy it back later for less money.
Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company.
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice and is for educational purposes only.
Index returns are for illustrative purposes only and do not represent actual investment performance. Index returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results
Investing involves risk including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments. Mortgage-backed securities are affected by, among other things, interest rate changes and the possibility of prepayment of the underlying mortgage loans. Mortgage backed securities are also subject to the risk that underlying borrowers will be unable to meet their obligations.
Diversification may not protect against market risk. There can be no assurance that goals will be met.