We’re a quarter deep into 2020, but these past three months have felt like an eternity given how fast the world changed.
The U.S. economy was on a solid trajectory at the beginning of 2020. When the year started, we were optimistic about positive returns and moderate economic growth, and we hoped businesses would increase capital expenditures to drive late-cycle activity.
Since then, we’ve had to process two “black swans” (or large, unexpected events) happening simultaneously — coronavirus and a historic oil shock. We expect both issues will continue to be the largest drivers of market performance in the second quarter.
The coronavirus spread across the globe at a rapid pace. In the two months since the virus landed in the U.S., over 300,000 cases and 9,500 deaths have been recorded, and swaths of the economy have gone on lockdown to contain the outbreak. Government officials expect the peak of the outbreak in hard-hit areas to be reached in the coming days.
Then, on March 6, Russia broke from a key OPEC alliance, fueling a price war among oil producers. Crude oil prices slid 54% in March to an 18-year low, and there’s uncertainty regarding a compromise between the two parties since then, leading to increased supply of oil at a time when demand is falling precipitously.
It’s tough to forecast what will happen in the coming quarter, but the environment will likely not get any less complicated. Still, there may be value in staying invested, even if we’re in for a bumpy ride.
A Historic Slide
All told, after declining 34% from its February 19 high, the S&P 500 Index ended the first quarter down 20%, its worst quarterly slide since the fourth quarter of 2008. While many investors hope the bottom of this bear has been put in, we believe it is too early to make that call. That said, buying into a decline can be beneficial, if you have some cash on hand. In the past nine bear markets, the S&P 500 increased an average of 10% in the 12 months after it first closed down 20%. Two-thirds of bear markets since 1950 bounced in the year after the bear market started. And staying invested has proven to be a winning strategy, as stocks have been resilient over the years. The S&P 500 has posted 7% annual returns since 1950, even while enduring those nine bear markets.
To be certain, history shows bear markets can be a long and somewhat exhausting process. Since 1950, bear markets have taken an average of 28 months to go from the bottom of the selloff to their pre-bear highs (according to CFRA data).
U.S. Economic Future
Economic activity has ground to a halt from coronavirus shutdowns, and there’s little clarity on when these measures will be lifted. That makes it hard to project how long and how deep the likely recession will last.
The impact has slowly bled into data, most distinctly in job market reports. Nearly 10 million people filed for unemployment in the last two weeks of March, smashing the previous two-week record of 1.4 million claims (October 1982). Many of the jobless claims were from restaurant and retail workers affected by the shutdowns. More Americans than ever before are expected to file for jobless claims as self-employed, gig workers, and freelancers are able to apply for the benefit for the first time ever. Traders and investors alike will be closely watching this particular weekly data point and its four-week moving average for clues into when jobs losses will bottom.
It is widely expected for the economic data to get significantly worse as the second quarter unfolds. U.S. consumers, which account for about 70% of gross domestic product (GDP), are already showing signs of nervousness about the future. In March, the Conference Board’s Consumer Confidence Index slid the most since August 2011. Additionally, manufacturing data, regarded as a bellwether for economic activity, has started to deteriorate as well.
We’re not sure how severe this downturn will be. Even Wall Street economists have struggled with quantifying the coronavirus’ economic hit. While nobody has a crystal ball, some firms have predicted a 20–30% GDP drop in the second quarter. The extent of the economy’s response will depend on how effectively the U.S. can flatten the curve of coronavirus cases and how efficiently government officials can reopen the economy. The sooner we can get the virus contained, the sooner economic activity can restart. That’s not an easy task, though, and global cases continue to rise, though some green shoots are beginning to surface. Italy’s daily new case count and death toll are showing clearer signs that the country is moving past its peak. New York state reported fewer deaths on April 4 from the prior day, the first decline in deaths since the outbreak began. While a very early sign, it is a welcome one.
Earnings Slashed, but Not Valuation
It has become increasingly difficult to forecast earnings for 2020, given the uncertain economic environment and the shuttering of various businesses across the country. As we approach the first quarter reporting period, set to kick-off mid-April, several companies across industries have already suspended or withdrawn guidance. Consensus estimates typically closely follow corporate guidance, making the current estimates potentially less credible than in the past.
Current expectations are for S&P 500 earnings to decline in each of the first three quarters of the year before recovering to flatline growth in the fourth quarter. Estimates were sharply reduced during the month of March as the impact of coronavirus became somewhat more understood by the market. First quarter estimates were reduced by 8 percentage points to an 8.4% decline from a 0.2% drop on March 1. Second quarter projections were sharply reduced, from 2.8% growth at the start of the month to a 17.9% decline now. Full-year earnings growth is expected to decline by 8.3% to $150 per share, from $173 in early March.
That brings the valuation of the S&P 500, based on a forward price-to-earnings (P/E) ratio, to 16.5x. That is a small premium to the ten-year historical average of 15.7x. One could argue that a premium or in-line P/E multiple could be warranted given the low inflation and low interest rate environment. But, in our opinion, the slowdown in earnings growth is expected to be substantial and that should be better reflected in the multiple. While the 8.3% decline in EPS in 2020 might be close to fair, and we won’t be sure until we have a better read on economic activity, S&P 500 P/E multiples have averaged 11.7x in prior recessions (according to CFRA). That suggests that we could retest the late March lows in the market, or at the very least, go a bit lower before we begin to drive toward prior highs.
The Bright Spots
There’s good news, though. Policymakers quickly responded to the coronavirus outbreak from all fronts: monetary, fiscal, and health care. Last quarter, the Federal Reserve (Fed) pulled out all the stops, using several mechanisms to stabilize the financial system including cutting interest rates to zero, opening an emergency lending window for banks, and committing to injecting trillions of dollars into several different markets. U.S. lawmakers followed that lead, passing a $2 trillion fiscal stimulus package that could benefit consumers, businesses, and hospitals. Health officials have advanced coronavirus research, and we’re seeing new innovation on the medical front.
Policymakers’ proactiveness will help soften the economic blow. A strong policy response was clearly needed, and based on recent action, we expect policymakers will continue to step in. There’s even talk of another fiscal stimulus package on the way. We believe the U.S. budget deficit is concerning in the long run, but that shouldn’t prevent policy from doing “whatever it takes” to support the economy right now. The level of stimulus provided is unprecedented in its size and speed, and if combined with a thoughtful policy to reboot the economy once the virus is contained, it could support strong growth on the other side of this crisis.
We’re also seeing signs that investors are feeling more confident about stocks’ near-term outlook. Intraday swings have calmed, and the VIX (a “fear gauge” for stocks) has dropped significantly from record highs reached in mid-March. VIX futures also show investors in those products expect volatility to gradually decline over the next several months.
The word utilized the most throughout our outlook is “uncertainty.” It is fair to say that word best describes the way we view the second quarter. Most investors are looking past that uncertainty with optimism for a better tomorrow. We share that view but believe the market may still need to take time to better reflect the uncertainty ahead of us.
The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.