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But this week the message is loud and clear: the recession is hitting hard.
After a stimulus-driven rebound for the S&P 500 Index, the chaos in oil markets is proving too much for investors to ignore. Crude is now pricing in no less than total demand destruction, and U.S. stocks are slumping as the fallout intensifies from the prolonged economic lockdown.
Oil is on the front line of the turmoil, but it’s far from the only asset that has been ringing alarm bells. Corporate bonds have recovered thanks to policy support, but fear of default is rife.
Government bond yields near historic lows point to expectations that virus-induced pain will be with the world for months or years to come.
“We are left with a situation where we have pretty dire economic conditions at the moment, a collapse in corporate earnings and markets essentially pricing in V—shaped recovery or a far too optimistic scenario,” said Brian O’Reilly, head of market strategy for Mediolanum Asset Management. “Most parts of the market are priced for a recession — we can take bonds or gold or oil. Just equity investors have gotten a little bit ahead of themselves.”
No asset is screaming a louder warning than oil this week. The price for a barrel of West Texas Intermediate crude for May delivery plunged below zero on Monday for the first time in history ahead of the expiry of contracts today.
While technical factors like vanishing storage capacity are at play, the demand outlook is dire. An easing of lockdowns is set to be sporadic and staggered, and legacy impacts such as altered consumption habits could be lasting. Small wonder June contracts also fell more than 45% at one point Tuesday.
“The hit to demand from virus containment measures will mean that the oil market will remain oversupplied for much of this year,” the team at Capital Economics wrote on Tuesday. “That said, we do expect prices to start to pick up later this year in tandem with somewhat stronger global economic activity.”
Optimism on a 2021 rebound is one reason stocks had proven so resilient to disruptions in other market corners. Anchored by a recovery in large-caps and tech companies, the S&P 500 Index gained 28% from its March low to the end of last week.
That caused all manner of hand-wringing on Wall Street on the perceived disconnect between equities and the economy. Every piece of data from retail sales to home building and surveys of manufacturing sentiment has been dismal across America, with policy stimulus found wanting so far.
Read more: Wall Street’s Bulls Drive Epic Market Split From Grim Reality
The acute pain from the oil crisis also threatens to upend the recent calm in the corporate debt market, where a wave of energy company defaults is expected.
U.S. junk bond spreads remain far below the 1,100 basis points they reached a month ago, but they snapped a two-day rally amid the oil wipeout Monday, with spreads widening 15 basis points to 720 basis points.
The argument is that credit stability is a product of emergency Federal Reserve action and little else. The U.S. central bank has unleashed hundreds of billions of dollars of bond buying in a bid to keep markets functioning, including support for corporate obligations and even some high-yield debt.
“The signal of intent from policy makers has been so strong that they have changed the balance of risk,” said Karen Ward, chief market strategist for EMEA at JPMorgan (NYSE:JPM) Asset Management. “They have taken away the left-hand tail — the risk that the market could be down another 30%.”
But that’s unlikely to prevent a wave of failing companies. The U.S. corporate high-yield default rate will likely exceed 4% this month, up from 2.9% at the end of March, Fitch Ratings said last week. That would be the highest in more than three years.
All told the “Great Lockdown” recession — possibly the steepest in almost a century — has the likes of James McCormick (NYSE:MKC) at NatWest Markets shifting to a negative stance on risk. He thinks recent stock gains have been excessive.
“Oil prices exaggerate the level of global weakness, and equity exaggerates the potential for recovery,” the strategist said. “They are both wrong as global growth guides.”
©2020 Bloomberg L.P.
