Stocks sold off hard on Tuesday on fresh virus fears, even as oil continued its rebound.
All three major U.S. indices dropped, with the S&P 500 falling 2.07%. The 10-Year Treasury yield slipped to 0.68% from 0.72%, signifying a considerable move into the safe bond. Crude oil rose more than 6% to over $25 a barrel, as Saudi Arabia announced a production cut of 1 million barrels per day—albeit a marginal cut. The risks are currently outweighing the benefits that arise from a strong oil market.
Energy fell, even as oil rose. Stocks have rallied in April partly on the back of a recovery in oil prices, but oil stocks have reflected much of that price rise, as crude oil is now up 157% from April 10. While cyclical sectors were feeling the heat the most, the SPDR Energy ETF (XLE) - Get Report only fell 1.76%.
Other economically-sensitive sectors like banking, industrials, and consumer discretionary fell hard. Another strong dose of risk-off sentiment showed up in small cap indices, with the Russell 2000 down 2.7%. Small caps can be more economically sensitive and many of them currently have heavy debt loads, making them higher volatility.
Investors are fearful that as states reopen, a meaningful spike in virus cases could ensue, resulting in further lockdowns. Even with tens of trillions of dollars of monetary and fiscal stimulus, another lockdown would elongate the economic recovery.
Dr. Anthony Fauci, the White House’s trusted immunologist, told Congress in a testimony Tuesday that reopenings could be premature and highly dangerous.
With the drawdown Tuesday, the equity risk premium—or the expected rate of return for a year in stocks in excess of the yield on the 10-Year Treasury bond—has risen to almost 4.5%. The higher the risk premium goes, as prices fall, the more nervous stock investors are. The risk premium was below 4% days ago and in a healthy economic environment it sits at around 3.5%.
Here’s what Wall Street said:
Matthew Harrison, Head, Biotechnology Research, Morgan Stanley:
“Open states have a flat or increasing number of new cases compared with closed states and European countries.”
Tony Bedikian, Head, Capital Markets, Citizens Financial to TheStreet:
“As things open up, how will he virus data still look? Will it be steady? Or will it still spike? If it spikes, we could have a big pullback because consumers will dial things back again.”
Alessio de Longis, Senior Portfolio Manager, Invesco:
“We believe this macro environment warrants a defensive portfolio posture. We have not made major changes to our asset allocation and continue to favor an overweight exposure in investment grade credit and defensive equity factors. Base scenario: Recovery begins in third quarter with high volatility and sideways markets, with risks of fall back to contraction. Within equities, we may favor US equities over developed ex-US and emerging markets, growth over value, large caps over small caps, and defensive factors such as quality and low volatility."