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Market Posts its Worst Week Since August

Even though the major indices were only down about 1% last week, many investors are asking what happened? Fourth quarter 2019 earnings season is still just getting under way with 17% of S&P 500 companies reporting results, the numbers are solid. 73% of those companies that have reported have seen an average earnings  increase of 3.2% above estimates. 67% of those companies are seeing an average sales increase of 1.3% above estimates. So, why the pullback?

First, and widely reported on, the outbreak of the coronavirus in Wuhan, China. Memories are still fresh from the SARS epidemic of 2003. However, the World Health Organization says it’s still too early to declare a global health emergency. As of this writing, 1,000 cases have been confirmed with the death toll standing at 56. A third case has been reported in the U.S. Everyone expects the cases of coronavirus to still increase globally over the next few weeks or months. But in comparison to what we see in a typical flu season in Americathe numbers are quite small. In the U.S. this flu season, there have been 120,000 hospitalizations and 6,600 deaths related to influenza. That’s why officials encourage everyone to get a flu shot. This is especially true for children over six-months old and seniors.

The second possible reason for the markets pullback last week is due to the Fed’s recent actions with regard to injecting liquidity into the repurchase-agreement market. Simply put, to keep the economic wheels greased, the Fed pumps money into money markets by issuing repurchase-agreements and buying short-term T-bills. This helps banks with liquidity and keeps them in-line with increased capital standards enacted after the 2008 financial crisis.

The reason this is important to last week’s pullback is how the Fed’s actions have changed so far this year. In 2019, the Fed not only cut interest rates three times, they also expanded their balance sheet by $300 billion since last September by pumping liquidity into money markets. During the last quarter of 2019, the value of U.S. stocks grew by more than $3 trillion. However, by January 22nd, the Fed has reduced their balance sheet by $25 billion as the market pulled back slightly. You can see how the effects of liquidity combined with low interest rates can fuel the economy.

Since the 2008 financial crisis, the Fed has worked hard to keep liquidity high in short-term money markets. The most notable policy a few years ago was called Quantitative Easing. That was when the Fed bought billions of dollars of mortgage bonds at a time nobody wanted to own them and liquidity vanished. Since then, the Fed’s balance sheet currently stands around $4.5 trillion. The central bank needs to whittle down this debt without disrupting markets. The concern is how the Fed  achieves this.