by Ralph Cole, CFA
Director, Equity Strategy and Portfolio Management
Officially a Bear Market
While the duration, severity and economic toll of the novel coronavirus COVID-19 are yet to be known, this week investors abandoned any attempt to calibrate market prices using fundamentals and engaged in wholesale panic, selling off equities in all markets around the world. This free fall is the third fastest decline in history, surpassed only by the crash of 1987 and October of 2008 during the great financial crisis. With this selloff, the S&P 500 is now down 20 percent from its February 19 high... and therefore officially in “bear market” territory... which is conventionally defined by a decline of at least 20 percent.
Despite the rapid fall in equities prices, we were mostly pleased with the response from fixed income markets. It’s important during times of stress that the “plumbing” of the system continues to work. This was mostly the case this week, and it should improve with the Fed’s injection of up to $1.2 trillion into the financial system —this is to assure that our markets continue to function properly.
COVID-19 itself is not what is dragging the market down but the economic repercussions from social distancing and precautionary measures taken to stop the spread of the virus. These unprecedented measures will have a large negative impact on U.S. economy and global growth in the coming months. How long that impact continues remains to be seen. Our best estimate is that the virus peaks in the second quarter or third quarter of 2020.
Whether reasonable or not, in short order the market has now largely discounted an imminent recession. Below are all the bear markets associated with recessions and the succeeding rallies since 1950. You will note that the average selloff is around 27 percent and the average rebound is approximately 39 percent over the next 12 months. Remember: it is important to be patient.
Source: Strategas
Markets usually rebound in response to stimulus provided by lower interest rates from the Federal Reserve and sometimes it comes from fiscal policy, such as government spending or lower taxes. This cycle looks to be no different. As a matter of fact, almost every region in the world is providing some sort of monetary and/or fiscal stimulus. It is often said that when governments start panicking, markets stop panicking. Angela Merkel, Chancellor of Germany, stated this week that Germany would do “whatever it takes” to combat the virus and its economic impact.
Where do we go from here?
We cannot pretend to know what Covid-19 and its ancillary effects will bring in the coming months but, when we look ahead to 2021, we utilize normalized earnings. We think stocks are attractively valued. Depending on whose estimates you use, the S&P 500 should earn anywhere from $165 to $175 in 2021, and, by using those estimates, the S&P 500 currently trades at 15.5x and 16.5x. When you compare that to the 10-year U.S. Treasury at just .9 percent, stocks are starting to look very attractive, as do other higher-yielding asset classes such as real estate and real assets.
Week in Review and Our Takeaways:
Stocks continued their rapid fall, which has led governments and central banks around the world to provide stimulus to the global economy
Stocks are looking attractive at these levels