The fastest market correction on record has been replaced by the fastest bear market on record as many major stock markets broke the -20% decline threshold last week.
Just over three weeks ago, North American markets were reaching all-time highs.
On March 12, the TSX was down 12.3% and the S&P down 9.5%, the biggest daily loss in the U.S. index since 1987.
If it’s any comfort to you, that faithful day in October 1987 saw the market drop over 20% in just one day.
Yet the speed of this stock market decline has put the metal to the test of just about every investor.
The bull market that started in March 2009 is now over. For years, people have warned that the bull would end because of issues such as poor profit or sales growth, or lukewarm economic growth, or excessive central bank interference, or even big policy mistakes. on the part of governments – none of them have. Instead, it was a virus.
A virus that created so much uncertainty and fear that investors rushed to hit the sell button, only slowed down by regular hand washing and trips to buy toilet paper (a priority that still confuses me).
While this was a very hard sell off and we don’t know if the bottom is near, let’s not forget that the US stock market rose over 31% in 2019. In fact, the S&P 500 was even higher. before Monday March 16. ) than it was at the start of 2019. The TSX is less encouraging, or more encouraging depending on how you look at it. The TSX was around 14,000 at the start of 2019 and is now at 12,600. It is sobering to see that the TSX has now been stable over the past five years (including dividends).
The market tries to quantify a bunch of unknowns. How will the virus pandemic play out in other countries like the United States and Canada?
With more and more people working from home, canceling trips and other projects, and stocking up on toilet paper, by how much will economic growth contract? It is safe to say that we are looking at growth that will dissipate and could potentially contract for a period.
Will this prove to be transient or prolonged?
How will the operations and profits of the business be affected?
There are potential winners such as couriers, cleaning supplies, companies with connectivity platforms, and of course, streaming services like Netflix where the frenzy is likely to increase. The losers far outweigh the winners, however, so we expect earnings to contract significantly in the coming quarters.
The unknowns and uncertainties have already trickled down to stock prices, with valuations hitting very low levels in some pockets. Canadian banks are trading at 7.6 times earnings. If you agree that earnings can be at risk, how about a 5.8% dividend yield? The S&P 500, which was trading over 19x its earnings in mid-February, is now trading at 14x. Again, if you don’t buy earnings because they are more uncertain, the S&P book price is now 2.7x (Chart 2).
There is no shortage of anecdotal information circulating about the COVID-19 pandemic. While it may well be the most difficult health event in decades, the hysteria continues to escalate. Lessons continue to be learned on how to deal with this pandemic and action appears to be being taken at an increasingly rapid pace. Testing becomes widespread, sporting events are canceled, offices are sparsely populated as social distancing becomes the norm.
It is even very difficult to guess the various scenarios that could occur. China ignored the problem for months and then launched into very aggressive measures. Now the active cases there are on the decline. The virus was clearly spreading in Italy before it was detected and aggressive measures implemented later. On the other hand, Korea has launched very quickly into strong measures and is starting to see the number of active cases level off. Taiwan has largely avoided the virus so far, using cell phone isolation and location tracking to see who an infected person may have contacted.
It is extremely difficult to say how widespread the virus is in the United States given relatively limited access to testing. Other countries, like Canada, may very well have a head start with protocols developed during SARS. Our geographic distance from the epicenter could also work to our advantage. Still, it’s anyone’s guess.
The market will likely overcome the virus long before we as individuals. For example, given the market downturn over the past three weeks with all the news about the number of viruses, deaths, and sporting events canceled, among other developments, the price may even be some pretty dire news now. . If the news comes less well, the market goes down; if better, the market goes up.
We continue to be strongly focused on the trajectory of active cases around the world, which continue to increase (Figure 3 above). Slope is the key – steepening is bad and flattening is good. Considering 11,000 new net active cases on March 14 and 12,000 on the 15th, this is not encouraging. But the daily information is noisy considering the lots of tests.
Savings and gains
It will come as no surprise when economic data begins to ease around the world in the coming months. The impact on behavior is already starting to show up in survey data, and hard economic data will follow. Chart 4 is the consensus forecast for global GDP. We’re used to seeing these forecasts revised downward as the year progresses, but the 2020 forecast drops very quickly. There may be some reprieve for inventory storage, but that will be a minor benefit. We are probably looking at negative GDP growth for many countries.
Employment data will also be affected in the form of rising unemployment. This could start to bring down other economic dominoes and turn a temporary disruption into a full-blown recession. Or, it won’t.
One positive aspect is that the policy has certainly been and continues to be favorable. After the sharp drop on March 12, a host of central banks and governments announced plans for fiscal easing and stimulus. On March 13, the Bank of Canada cut the overnight rate by half a percentage point to 75 basis points (bps). This comes on top of the 50 basis point drop from last week. The Fed acted again over the weekend by reducing the Fed Funds rate from 1.25 to 0.25 (or effectively to zero because that’s the upper band) and to $ 700 billion from quantitative easing. I don’t know if it’s QE4 or 5, it’s confusing. These efforts will lessen the economic shock and help the markets to function.
Earnings estimates have started to fall and we expect this to accelerate (graph 5). Often, analysts do not change estimates on the fly and will wait until the first quarter earnings season before adjusting. This will result in a significant drop in estimates during the month of April.
We would like to believe that the worst of the equity market downturn is over, but no one knows for sure (markets appear to open down nearly 10% this morning). There were more sellout signals last week, including VIX peaking at over 70 and the percentage of investors who are now bearish is over 50%. It’s encouraging. However, the way forward is fraught with uncertainties, the trajectory of active COVID-19 cases, the extent of the reduction in economic growth, and the subsequent impact on corporate profits.
After a 25% drop, a lot of the bad news may be embedded. But again, this market has punished anyone who previously thought it was time to buy. The one-day drop on March 12 – a record over 30 years – bodes well for future returns, as does the rebound in bond yields. Time will tell us.
Source: All charts are sourced from Bloomberg LP and Richardson GMP, unless otherwise noted.
The opinions expressed here are solely those of the authors and do not represent the views or opinions of any other person or entity.