This is what a market panic feels like. But now that the storm has made landfall, it’s time for unnerved investors to sort out a few things: What just happened, why did it happen, and, most important, what should they do next. The pros have some advice: Don’t be too cautious.
What just happened? The coronavirus was declared a pandemic by the World Health Organization. Saudi Arabia announced a huge output increase, sending oil prices plunging. Forrest Gump contracted the coronavirus. There are no basketball scores to check. Baseball won’t start on time this spring. And President Donald Trump declared a national emergency on Friday after announcing a European travel ban on Wednesday.
Investors had a brutal week. All three major U.S. indexes fell into bear-market territory, ending an 11-year bull market in U.S. stocks.
The Dow Jones Industrial Average fell 2,679 points, or 10.4%, to 23,185.62. The S&P 500 dropped 8.8%, to 2711.02, and the Nasdaq Composite dropped 8.2%, to 7874.88. It was one of the 20 worst weeks of all time for the Dow. The weekly Dow drop came despite an epic 1,985-point rally on Friday.
The numbers are breathtaking. They will be talked about by our children’s children.
“This stinks, it’s horrible, we hate it,” Bill Smead of Smead Capital tells Barron’s, reflecting on the recent trading action. Unmitigated selling pressure causes a panic. No one likes a panic, but stock-market history is dotted with them.
“Most of the clients we speak to don’t feel like they are panicking,” says RBC head of U.S. equity strategy Lori Calvasina. That might be true, but that is the nature of a market panic. No one suggests people act against their own economic self-interest. But in a panic, the buy orders dry up. Traders step back because of extreme volatility. That leaves, essentially, an imbalance of sell orders.
There are, of course, new risks for investors to discount. Some, like a pandemic, are hard to understand. If investors go to Wikipedia to learn the definition of pandemic, it’s a sign things aren’t normal.
All the stress can compress investors’ time horizons. Falling 2020 earnings estimates start to dominate better potential earnings in the future. The S&P 500 now trades for less than 13 times 2022 estimated earnings. Things should be back to normal by then. It is also what stocks traded for around the lows of 2002, 2016, and 2018.
That’s the what. The why is the easiest question to answer. It is the virus—and the fact that there are no good precedents to figure out when the crisis will pass or how many people will be significantly affected.
“I have purposefully stayed out of the science,” Calvasina says. “I’m interested in what the market is telling me.” And what the numbers show her is the market is pricing in a recession. “Last week the market was trying to hold 2,700,” she notes. That lines up with other 10% to 20% drops in the aftermath of the 2008-09 financial crisis. Those were market corrections. They didn’t imply recession.
The S&P 500 dipped below 2,700 this week before closing higher on Friday, after a final-hour rally. The next negative milepost Calvasina is watching for is 2,300. If the market breaks that level, then it is no longer pricing in just a garden-variety recession. It would signal worse things are on the horizon.
Even during the depths of Thursday’s 9.5% decline, the index hit only 2,479, well above her 2,300 barrier. As hard as it is to believe, the market tells Calvasina that it won’t be as bad as the financial crisis. The market doesn’t expect a grinding, year-plus slowdown accompanied by a 50% drop in stock prices. (The average peak-to-trough recessionary drop in U.S. stock prices is about 30%.)
What to do next? The pros advise against excessive inaction.
“Hiding in the market’s most conservative names was a nice idea three weeks ago, but it isn’t the best idea today,” David Donabedian, CIBC U.S. private wealth chief investment officer, tells Barron’s. “Just focus on good business fundamentals”—and don’t switch to names with the lowest beta or price/earnings ratio. (Beta measures a stock’s underlying volatility and correlation with the market.)
Calvasina agrees and is staying overweight in the industrial sector. “It is underperformed recently, but the sun will rise on the industrial economy again,” she says—probably by the middle of 2020, she calculates. Calvasina also recently upgraded her rating on the health-care sector, but not because of the virus. Former Vice President Joe Biden’s resurgence in the Democratic presidential contest reduced the “political risk” within that sector.
“This [volatility] will reverberate for a number of months,” Smead adds. He has 40 years of market history under his belt. He recommends shopping, too, but his shopping list includes his favorite stocks—which include home builders and banks—and not hand sanitizer.
Write to Al Root at firstname.lastname@example.org
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