Monthly Market Risk Update: February 2020Learn more about this firm
My colleague Sam Millette, senior investment research analyst on Commonwealth’s Investment Management and Research team, has helped me put together this month’s Market Risk Update. Thanks for the assist, Sam!
It’s time for our monthly look at market risk factors. We had a strong start to the year, with U.S. markets at all-time highs by mid-January. But a risk-off sentiment driven by the spread of the coronavirus from China spooked investors, leading to modest declines for equity markets at month-end. Markets have since recovered and moved back to new highs, but that does not necessarily mean the risks have disappeared. Just as with the economy, there are several key factors that matter for the market in determining both the risk level and the immediacy of the risk.
Recessions are strongly associated with market drawdowns. Indeed, 8 of 10 bear markets have occurred during recessions. As we discussed in this month’s Economic Risk Factor Update, right now the conditions that historically have signaled a potential recession are not in place; in fact, conditions are improving. There are, however, signs that risks are out there, highlighted by the recent re-inversion of the 10-year and 3-month yield curve at month-end. On an absolute basis, most of the major signals are not yet in a high-risk zone, and January’s data releases largely came in better than expected. With that being said, all five of the major economic signals are still at a yellow light. As such, we have kept economic factors at a yellow light for February.
Economic shock risk
There are two major systemic factors—the price of oil and the price of money (better known as interest rates)—that drive the economy and the financial markets, and they have a proven ability to derail them. Both have been causal factors in previous bear markets and warrant close attention.
The price of oil. Typically, oil prices cause disruption when they spike. This is a warning sign of both a recession and a bear market.
The price of oil increased by 11.7 percent on a year-over-year basis in January. But this increase was largely technical in nature and due to a sharp drop in oil prices at the end of 2018 that lasted through the first few months of 2019. On a month-over-month basis, prices actually declined by 3.8 percent in January, despite the increased tensions between the U.S. and Iran. January’s average spot price per barrel of $57.53 is well below the one-year high of $63.86 that we saw in April, so there is no immediate cause for concern. As such, we’ll leave this indicator at a green light for now.