Answers to FAQs about the recent market disruption – Part 2

Global Market Strategist Brian Levitt provides additional perspective on the impact of the coronavirus.

Mar 17, 2020 | Brian Levitt

 

1. Is the trajectory of coronavirus cases in the US more likely to resemble that of South Korea, where cases appear to be peaking or Italy where the number of new cases continue to climb? 

Unfortunately, US cases appear to be following a similar trajectory to that of Italy. Italy, on February 23, 2020, had reported 155 cases. Ten days later that number had climbed to 3,089, and by the end of last week stood at 21,157. Reported cases in the US stood at 159 on March 5, 2020. Nine days later that number had climbed to 2,836.1) It is becoming increasingly apparent that the US will follow Italy’s lead and soon be heading towards a prolonged period of mandated isolation with large segments of the US economy shut down.
 

2. What facts do we know about the coronavirus?

According to a study of 44,000 cases in China:2

  • 80.9% of the cases are considered mild and flu-like in nature.  13.8% of the cases are listed as severe and require hospitalization, while 4.7% are listed as critical and require intensive care.  The potential number of people needing to be hospitalized and to require intensive care will potentially be large enough to overwhelm the US healthcare system.
  • Most coronavirus sufferers recover, but the fatality rate (0.7% in South Korea, 3.9% in China, and 5.0% in Italy) is orders of magnitude higher than that of the common flu. (These numbers are likely elevated because people who are asymptomatic or only experiencing minor symptoms are unlikely to be tested and/or counted).
  • Those aged 60+ are most at risk, especially those with existing conditions such as cardiovascular disease, diabetes, chronic respiratory disease and high blood pressure.
     

3. What is a bad- and even-worse-case scenario for the US equity market? 

The US stock market has already declined peak to trough by 29.5%, with a large majority of stocks in bear market territory.3 Peak to trough we are now down 29.5% as of market close Monday, March 16. 

Market bottoming may be a prolonged process and will not likely occur until the number of new cases appear to be peaking and economic activity begins to stabilize.
 

Here’s a framework to think of a bad-case scenario for the broad US equity market:

  • The S&P 500 Index, at its peak on February 19, was trading at price to trailing 12-month earnings ratio (P/E) of 21x.4 The current P/E is 17x.5 In the last 7 recessionary bear markets, the price to earnings ratio contracted, on average by 25%6 which in this instance could result in a P/E of 14x.
  • S&P 500 earnings stood at $165 per share at the peak of the cycle.7 Earnings could contract by as much as 20% in a full-bore global recession, down to roughly $132 per share.  
  • Per that framework, we could envision a bad to even-worse-case scenario that would bring the S&P 500 down toward 1,800 to 2,000.    
     

4. Why did the US Federal Reserve (Fed) lower interest rates to zero?  Aren’t they already out of ammunition?

In addition to fostering maximum sustainable employment, the other prong of the Fed’s dual mandate is to maintain price stability. Inflation expectations have been plunging. The Fed had to respond. An independent central bank with the world’s reserve currency is unlikely to run out of ammunition. The Fed will continue to massively expand its asset-purchase program ($700 billion in new purchases announced)8 and will continue to provide emergency liquidity provisions to the parts of the market in distress. The Fed can’t solve this problem alone, but we believe investors can rest assured the Fed will act aggressively to prevent a global financial crisis from occurring.
 

5. Should we expect more fiscal stimulus?

Yes. The first round of stimulus (roughly $50 billion9) is designed to provide near-term support to workers through paid sick leave and expanded unemployment benefits and to expand health-care needs, including free coronavirus testing for those without insurance and expanded Medicaid benefits.  We expect the next round of stimulus to be substantially larger and to include targeted support for businesses, communities, and households.  
 

6. Should I be worried that this will result in the next global financial crisis?

2008 does not appear to be the right lens for viewing this crisis. This is a very different environment from 2008, when banks globally were significantly over-levered. Banks, heading into this crisis, are better capitalized than they have been in years. Interbank lending rates, like credit spreads, have widened in recent weeks but are still below levels reached during the 2016 market drawdown.10 If there is any type of disruption in the interbank lending or credit markets, then we would expect the Fed to be very aggressive in providing emerging liquidity provisions. 


See Part 1 for more answers to the FAQs we’re hearing from investors and advisors.
 

^1.Source: World Health Organization, as of 3/14/20
^2.Source: The Chinese Center for Disease Control and Prevention, as 2/29/20
^3.Source: Bloomberg and Standard & Poor’s, as represented by the S&P 500 Index, as of 3/16/20
^4.Source: Bloomberg, as of 3/12/20.
^5.Source: Bolomberg, as of 3/13/20
^6.Source: Bloomberg, Empirical Research Partners, as of 3/13/20
^7.Source: Bloomberg, as of 3/13/20
^8.Source: US Federal Reserve
^9.Source: US Congress
^10.Source: Credit spreads are represented by the Barclays US High Yield Corporate Bond Option Adjusted Spread and interbank lending rates are represented by the Federal Funds Rate Forward Rate Agreement Overnight Index Swaps.

 

Brian Levitt is the Global Market Strategist, North America, for Invesco. 
 

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