Q1 2020 Market Update
Despite the waterfall decline over the last month, reflecting the demand shock and economic impact of the Coronavirus pandemic, there have been small signs that a bottom may be developing.
The stock market had a waterfall decline over last month. The S&P 500 Index had dropped 34% at one point, reflecting a recession and anticipation of a big drop in corporate earnings. The selling pressure peaked when the Volatility Index (VIX) hit an extreme point. The S&P 500 had eight consecutive days of at least 4% daily movement up or down, breaking the Great Depression’s record of six. The VIX is off its highs, but continues to trade at elevated levels, implying that those big up and down days of 4% are with us through April. Money market fund assets have surged by more than 8%, a sign that the decline is in its latter stage. Waterfall declines usually see a rally off lows and a re-test of its low. I think there will be a successful retest of the low in April - a bullish signal to buy equities.
Typically, after a bottom in a bear market, the returns are significantly above average over the next twelve months. Bear markets with the biggest annualized declines have been followed by four of the five global bull markets with the biggest annualized gains. Notably, this bear market decline occurred in record time, a few weeks, when it usually takes nine months. Steep declines are often accompanied by a faster recovery after a bottom is in place, so it does makes sense to stay invested.
The stock market is pricing in a “V” recovery in earnings in the second half of 2020, but I think it is more likely that the bottoming process will take some time and look more U-shaped. I do expect an earnings recovery, by the end of the year looks likely. Stock market valuations and current S&P 500 Index price level are presently looking past this earnings recession.
Corporate earnings could decline as much as 20% in 2020, putting earnings at $130 for the S&P 500. The declines will occur in the second and third quarters. Technology, health care and communications services sectors are projected to report best results. Any reliable forecast is dependent on how long it takes to bend the curve and get America back to work.
April’s macro-economic numbers will be utterly dismal, and Covid-19 cases and deaths will reach peak levels. Trump has stated that the next few weeks will be very “painful” and the White House predicts that 100,000– 240,000 could die in the U.S. before this is over. The hope is that infections in the U.S. and Europe will peak by late April. If so, sheltering mandates could be relaxed starting in May and our government stimulus would be sufficient to prevent lasting economic damage.
That scenario provides the backdrop to a U-shaped recovery in this year’s third and fourth quarters, with the S&P 500 Index ultimately trading at roughly 2,800 by year-end as earnings rise back towards pre-COVID-19 levels. Market valuation would rise from a recession P/E of 13 to 17.5 due to higher economic activity resulting from recovery efforts and stimulus.
A Covd-19 recession may sound like a reason to sell, but it is not. The stock market may have seen a low in March, but a successful retest of the March’s bottom is likely in April given unfavorable COVID-19 news by mid-April. Stocks typically begin to rise three to six months before a recovery. We are already in that window. Those who sell now are likely to regret it.
One last thing to note: This Is Not 2008. The typical culprits behind a recession are not present. This is not a normal recession caused by economic imbalances. This is a self-induced demand shock. Unlike 2008 and the Great Depression, the Federal Reserve is responding to this shock with enormous liquidity. The Fed also launched several programs to stabilize credit markets. And, this time the Fed’s actions were swift. In addition, the record fiscal stimulus has been approved to provide relief to small business, big business, and consumers.
I see the U.S. economy experiencing a sharp contraction in the second quarter, followed by a modest rebound in the third quarter, and even stronger growth in the fourth quarter. China is reaccelerating in response to declining new cases, and the global economy should ramp up in the second half as workers go back to work.