When $7 trillion is erased from stocks in 2 1/2 weeks, it’s safe to say investors are pricing in a lot of economic pain. One thing most of them are not yet bracing for, however, is a recession.
The view, drawn from a survey published by a Wall Street research firm on Friday, may sound fanciful, given the spread of the coronavirus and its rising threat to the global economy. But it’s not grossly out of line with price action so far in the S&P 500, which has fallen roughly as much as it did in its last six corrections. None of those episodes portended an economic contraction.
As harrowing as this sell-off has been, by almost any measure except velocity it remains a pipsqueak compared with the battering investors took at the end of 2018. In that episode, the S&P 500 plunged almost 19% while price-earnings ratios, the market’s main measure of sentiment, compressed to 16 times annual earnings. They’re a lot higher than that now at 19.3.
“The market’s saying ‘Ok, obviously equity valuations need to be significantly lower than they were before this started,”’ said Arthur Hogan, chief market strategist at National Securities Corp. “But pricing in a recession in the equity markets is probably not what’s happening right now.”
Anyone could be forgiven for assuming the worst after the week that just was. After twice righting itself after plunges, the S&P 500 fell 3.4% on Thursday and 1.7% on Friday, while measures of volatility hit the highest since 2011. The signal from bonds was ominous: 10-year Treasury rates touched record lows. Coronavirus infections topped 100,000 and outbreaks worsened around the U.S.
Still, in an investor survey conducted by Evercore ISI, less than half of the respondents said they expect the U.S. economy to experience two consecutive quarters of negative growth in 2020. While acknowledging the economic threat from the coronavirus has grown, about two-thirds anticipate the number of infected cases to peak in May.
Of course, one person’s confidence is another’s complacency, and there are analysts who see anything but panic among investors as evidence shares have further to fall. Conditions needed for a market turnaround include a reversal in investor positioning and “recession-like pricing across financial markets,” JPMorgan strategits led by John Normand wrote in a note Friday.
Obviously, not knowing how the outbreak will play out makes predicting its effect on growth impossible. But it’s also worth noting that the U.S. stock market was priced at a historically high multiple when the sell-off began. That complicates the calculus when trying to use reactions in equities as a litmus for how bad the virus’s impact will be.
“It’s entirely been driven by sentiment. What has been pushing the markets lower is P/E compression and that is a reflection of investors’ concerns about what is going on,” said Michael Geraghty, equity strategist at Cornerstone Capital Group. “The U.S. economy is undoubtedly strong. It would take a lot to swing it into a recession and I don’t think the virus is likely to do that anytime soon.”
To safeguard the economy, the Federal Reserve just delivered its biggest cut to interest rates since 2008 while President Donald Trump signed a $7.8 billion emergency-spending bill to fund a response to the outbreak. Larry Kudlow, Trump’s top economic adviser, on Friday opened the door for limited economic stimulus, though the administration’s preferred path appears to be more Fed action.
Traders remain leery on the market, with equity volatility spiking. The S&P 500 rallied more than 4% on two days of the week while tumbling on the other three. Good news is, the market managed to hold support at the intraday low at the end of February.
“With a lot of unknowns out there, the market will be more volatile and will pull back a bit but it doesn’t necessarily mean a recession,” Frank Ingarra, head trader at Greenwich, Connecticut-based NorthCoast Asset Management LLC, said in a phone interview. “Things could wrap up really quick and we could resume a bull market.”