stock market analysis

Stock market survival under Coronavirus Conditions

Can stock markets survive the Coronavirus?

The coronavirus pandemic has infected the stock market, putting Wall Street and investor psychology to the test. Also referred to as COVID-19, the Coronavirus has caused a sudden stock market crash the likes of which have not been seen since Black Monday in 1987 or the market meltdowns in 2000 and 2008.

Even top stocks to watch like Apple, Microsoft, Amazon, Nvidia and Alibaba have not been immune. While the coronavirus bear has created extreme stock market volatility and uncertainty, one thing is clear: At some point, a new bull market will begin.

As we wait for a follow-through day to signal a potential new stock market uptrend, here are some timely lessons on how to invest in this type of environment.

The coronavirus stock market correction arrived in a flash with Wall Street's sudden realization that the COVID-19 outbreak would not be contained outside China. The stock market correction began Feb. 25, as caseloads were spiralling in South Korea and Italy and a top Centers for Disease Control official warned Americans, "This could be bad."

Barely two weeks, 2,207 U.S. coronavirus cases, 48 deaths and more than 6,000 Dow Jones points later, we've only begun to learn how bad it will get. Yet the past few weeks also have brought encouraging signs that an aggressive public health response can control the outbreak. New coronavirus cases in China have slowed to a trickle, while infections in South Korea also have trended lower.

What lies ahead? Investors should prepare for any of three plausible scenarios for the coronavirus outbreak—the potential outcomes presented below draws from analyses by three forecasters. UBS and McKinsey this week laid out various ways the COVID-19 crisis could play out, following Morgan Stanley a week earlier.

The course of the coronavirus stock market correction — now a bear market — and the economic cost of the COVID-19 pandemic depend on how soon countries can safely return to something approaching normalcy. The latest developments have diminished odds for the most benign scenario.

Hillyer Riches is an Accountant in Caulfield providing taxation accounting and business advisory services.

stock exchange screen

How low can stock markets go?

While the stock market is typically a leading indicator of the economy — it tends to peak before the onset of an economic recession and bottom before an economic recovery — the unique nature of the ongoing COVID-19 epidemic has made forecasting an eventual stock-market recovery particularly tricky.

Although the cascade of negative headlines as increased coronavirus testing capacity reveals the extent of the outbreak in the U.S., some analysts are arguing that the equity market may have already begun a bottoming process and that equity prices are nearing their most attractive levels.

Since mid-February, the Dow Jones Industrial Average DJIA, -1.68%, the S&P 500 index SPX, -1.51% and the Nasdaq Composite Index COMP, -1.52% have all declined nearly 30%, marking the fastest onset of a bear market in history.

Jeff DeGraaf, founder and chairman of Renaissance Macro Research, wrote in a Thursday note to clients that he sees evidence of investor sentiment reaching such low levels as to be a contrarian indicator that points to attractive equity returns over the next three months.

As the chart below shows, investor sentiment, according to an Investors Intelligence survey, has fallen into the bottom 10th percentile of readings, which has been a good indicator of market rallies during the past decade.

"If we could add an anecdote, an emotional portfolio manager pleading on T.V. for what amounts to martial law reinforces the extreme in sentiment data we're quantifying," DeGraaf wrote, referring to a widely viewed interview of hedge fund manager Bill Ackman on CNBC Tuesday.

"Truthfully, we see the viral count as a side‐show at this point, and the market's main attraction being credit conditions and the ability of the Fed and global central banks to get in front of these deteriorating conditions," he added.

Central banks around the world have announced a variety of stimulus measures aimed at combating the economic impact of the epidemic. However, many investors and analysts have called for the U.S. government to create a lending program that would keep sound businesses afloat until extreme measures to combat the spread of the virus are no longer necessary and somewhat more normal economic activity can resume.

If the federal government can halt the panic in corporate credit markets, DeGraff argued, that could create a turning point in the stock market even if the health crisis continues to linger. "The viral news is likely to be bad when the market finds its footing."

Another reason to believe that the equity market may be nearing its nadir are dynamics in the government bond market. James Paulsen, the chief investment strategist at the Leuthold Group, pointed out in a Wednesday note that the recent rise in the yield on the 10-year U.S. Treasury note TMUBMUSD10Y, 0.596%, from about 0.6% Monday to roughly 1.1% Thursday could be a bullish sign for stocks.

He noted that marked increases in bond yields preceded significant stock-market declines in 1987, 1998, 2002 and 2008. "In each of these financial crises, both the stock market and bond yields eventually suffered sizable and sharp declines," he wrote. "After that, however, once bond yields posted a meaningful advance, in every case the bear market was nearing its end."

With stock prices sinking fast, a client emailed me, saying, "Your move, boss." So here is our move: Especially in this coronavirus crash, we continue to seek out what we always look for globally — high-quality businesses that we can buy at a significant discount to fair value. We are prepared for the possibility that every decision we make today will look wrong tomorrow, as we have no idea how long this market decline will continue. We are excellent with that, as long as these decisions are proven right several years out.

Our investment focus zooms out from this or the next quarter — where our vision is fogged — to years ahead, where paradoxically we have a lot more clarity. It is easy to look at the current decline as a curse. Still, if we look a few years out, we can expect to see that this sell-off provided the opportunity to add to existing positions on the cheap and to add more high-quality but undervalued stocks to our portfolios.

As famed value investor Shelby Davis observed: "You make most of your money in a bear market; you just don't realize it at the time." Stock prices today are the transitory opinions of Mr Market, who often is emotionally unstable. Mr Market did not carefully value your companies today and decide they are now worthless. No, he woke up in a panicked mood and indiscriminately marked them down as if they were overripe bananas at the grocery store.

The stock prices on your screen now say nothing about what these companies are worth. Nothing at all. But valuation is all that is going to matter in the long run. I promise you one thing: the value of your companies doesn't change 8%-10% a day, day after day.

Meanwhile, check out these Six Commandments of Value Investing — a chapter from my still unfinished book, where I discuss Graham's principles of value investing in depth.  This market had been a long time coming, and I have been saying publicly for some time that investors should go on the defensive, which means you should cut back on your equities exposure. Now, as a result of the recent developments, my expectation of a recession is even more strengthened than before," he said. He believes the GOP tax cuts passed in 2017 created a "sugar high" that pumped up economic growth for the first two quarters but was not sustainable since it was not tied to fundamentals, such as job training and education that could boost the economy for the long term.

Instead, the tax cuts prompted "enormous" stock buybacks by American corporations, while very low-interest rates helped boost corporate earnings by reducing borrowing costs. That led to a mentality among investors "that in the Trump administration, stock prices have only one way to go, and that is signed up." The result, Sri-Kumar said, was that stock market valuations were extraordinarily high and the market was "priced to perfection" — so long as there's no bad news in the world.

"I've been asked if the coronavirus was a black swan, an unexpected development," he said. "North Korea may have lobbed a missile. Last time it went past Japan and fell into the water. Next time it might hit a Japanese location. Then you have a pandemonium in global capital markets. If it hadn't been [the virus], it would have been something else."

He thinks an expected cut in interest rates by the Federal Reserve later this month will not do much to quell the market turbulence, and a general payroll tax cut the Trump administration is pushing for won't be of much assistance either. Instead, he said, President Trump and Congress must come together for a "very targeted fiscal approach" that would spend money on medical research and prevent smaller and midsize firms that employ the majority of people in the country from failing.

As of Mar. 12, only 29% of the active cases were in China, and the remaining 71% were in other parts of the world. Active cases mean the infected people who are still being treated and not yet recovered. While the situation is improving in China, COVID-19 is leading to lockdowns in countries like Italy, South Korea and Iran. Due to spiralling numbers, the U.S. and many countries in Europe are staring at a grim situation. German Chancellor Angela Merkel estimates that "up to 70% of the country's population could contract the Coronavirus".

Impact of this on global economic growth is going to be huge. The Organisation for Economic Co-operation and Development (OECD) has halved the global gross domestic product (GDP) growth projection for 2020 due to Coronavirus. The disease will obviously impact the Indian economy as well. "The current restrictions will impact most economic activities like travelling, consumption, etc. Manufacturing will be impacted due to supply chain disruptions and this, in turn, will delay capacity additions and CAPEX spending," says Brinda Jagirdar, Economist, SBI.

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climbing up graph

Crude oil war

To compound the global economic uncertainty, an ill-timed global crude oil war has begun. The demand by the Organisation of Petroleum Exporting Countries (OPEC) to further restrict production from April was rejected by Russia, resulting in the scrapping of existing restrictions. Increasing output at a time when demand is low due to the COVID-19 pandemic is terrible for the crude oil market.

 "Though there will be countercyclical rallies during times of central bankers' actions like rate cuts, the outlook is clearly bearish, and in the worst case, Brent oil can go down to $25 level," says Praveen Singh, AVP, Fundamental Research – Commodities & Currencies, Sharekhan Comtrade. However, the crude oil war is a blessing in disguise for oil-importing economies like India. "The negative impact of the pandemic on Indian economy will get cushioned by the fall in crude oil prices because it will help to bring down our current account deficit, fiscal deficit and inflation, etc.," says Jagirdar.

Financial sector woes

The domestic consumption slowdown, triggered by the failure of large financial institutions such as IL&FS and DHFL, is still lingering. Now we have another situation in the form of the Yes Bank crisis. Though only time will tell how the Yes Bank fiasco will shape up, the revival package for the bank is an excellent short-term step. "The Yes Bank crisis seems to be heading for a solution due to government and RBI actions. If that happens, at least one immediate worry will be out of the way," says Sarin.

While other commodities are down, gold has gone up because of the demand for a safe haven in uncertainty. The hope of rate cuts by global central bankers (the U.S. Fed has already cut rates by 50 basis points) is also keeping gold demand intact. "Our initial target for gold was $1,700. However, it can go up to $1,800 if COVID-19 is not contained soon and central bankers are forced to come out with more rate cuts," says Sing. The impact gold rally will be more for Indian investors because of the fall in rupee now.

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Earnings Suffering

It's safe to say the public panic surrounding the virus outbreak is now affecting the investment environment more than we had expected. We believe that earnings of listed companies will be significantly affected by the suspension of activities, events and public gatherings around the world, most prominent being tourism, as well as the "closure" of China to fight the virus.

We have revised our overall 2020 earnings per share (EPS) forecast for the market to 80 baht, down 20% from our previous forecast. We also note that the market's current price/earnings (P.E.) ratio is about 14, already one standard deviation below its average level. As well, we recently revised our GDP growth forecast for 2020 to 0.8%, which would be the lowest in nine years.

Though our base case sees the current market malaise as temporary, further revisions are possible should COVID-19 and the impact of the local drought worsen beyond expectations.

We are encouraged by data showing that new cases in China have fallen steeply, and we expect infections to peak in the first half, followed by a reasonably quick recovery in the second half. We still expect the EPS for the market to jump back to 100 baht on 2021 and note that the SET forward P.E. ratio is only 11 times, the lowest level since the global financial crisis of 2008.

Indeed, we believe the market is now oversold. Many stocks are currently trading well below their fundamental value. It's also important to note that many stocks are on their way to X.D. with yields already exceeding 8-9% amid the stock price plunge. Though severe, the impact of the outbreak should prove temporary and be followed by a rapid recovery.

Hence, we recommend investors start accumulating stocks that have been caught up in the recent sell-off despite having good fundamentals and limited exposure to the outbreak. Companies that fit the description and benefit from domestic-driven income include AOT, BAM, BTS and CPALL.

The tourism sector stands to surge when the outbreak eases, as demand for travel is now pent-up; this should directly benefit AOT later in the year.

Cheaper Assets 

For BAM, weak economic conditions mean the company should be able to accumulate assets at lower prices. But if the recovery is fast, BAM also benefits because it can liquidate assets quickly. Moreover, its current price level is well below its total asset value.

Meanwhile, openings of various mass-transit routes are slated for the near future, keeping the outlook bright for BTS. The virus outbreak has affected the company's operations as people avoid crowded areas. Still, we believe that the stock's comeback will be strong once the virus is contained, and confidence is restored.

In the domestic consumption market, CPALL retains a strong position. And now that it has a 40% stake in Tesco Asia, the door is open for the company to expand further and become a leader in both the convenience-store and hypermarket industries.

We acknowledge some market concerns that the Tesco Lotus deal will result in CPALL having to increase its capital. However, with only a 40% stake, the company can fully finance the transaction through debt instruments, and thus does not need to increase wealth. Shares are now ripe for gradual (not rapid) accumulation, as the current market downswing has brought valuations down to an attractive level.

Reflexive Response

The best-case scenario is that a reflexive response proves workable in the U.S., much of Europe and elsewhere. Under this scenario, the behaviour will adapt sufficiently to slow the spread of the Coronavirus.

Some coronavirus hot spots will require widespread closures of schools and public events, as in Seattle. Yet behavioural changes — such as more telecommuting and more at-home time for at-risk seniors — will slow the coronavirus infection rate and keep the health system above water. This is key to McKinsey's "Quick Recovery" scenario. "Younger people are affected enough to change some daily habits (for example, they wash hands more frequently) but not so much that they shift to survival mode and take steps that come at a higher cost," like keeping kids home from school.

A successful reflexive response also is implicit in Morgan Stanley's "Quick Containment" scenario. Assuming limited disruption beyond the first quarter, the S&P 500 could roar back to 3,250 this year, the firm says. The best-case scenario from the UBS economics team sees "a certain degree of additional disorder," as coronavirus cases outside China stabilize within 4-6 weeks. In recent days, the rate of new COVID-19 cases in the U.S., Europe and worldwide has been accelerating, outstripping the peak in China's worst days.

Time is running out. In the U.S., still-limited coronavirus testing has made it hard to identify and close off new COVID-19 clusters. For a time, the absence of identified cases provided a false sense of security. Now, the unknown scope of the coronavirus outbreak is fueling a panic.

Still, if new coronavirus cases in the U.S. and Europe do stabilize in the coming weeks, monetary and fiscal stimulus could power global equities to new highs this year, UBS economists wrote. Wall Street appeared to lean toward that favourable scenario earlier this week. Then came Wednesday's sharp sell-off and Thursday's thrashing, following Trump's E.U. travel order.

The stock market bounced Friday strongly, helped by a late flurry as President Trump declared a national emergency over the Coronavirus. He announced new aid, increased coronavirus testing and red-tape relief to try to contain the COVID-19 virus while shoring up the economy.

Still, the major indexes fell sharply for the week. With the coronavirus stock market correction now a full-blown bear market, investors have begun pricing in a gloomier outlook.

Economy dropping even lower in developing countries

Restrictive Response

The second, more painful scenario sees a rolling wave of coronavirus infection spikes that stress local and regional health systems in the U.S., Europe and elsewhere. Governments take more aggressive steps to enforce social distancing. A sharp economic growth slowdown ensues, extending through the second quarter. This coronavirus outlook roughly matches up with McKinsey's "Global Slowdown" scenario developed with Oxford Economics. It assumes the U.S. caseload surges to somewhere between 10,000 and a half-million.

"In Europe and the United States, the transmission is high but remains localized, partly because individuals, firms and governments take strong countermeasures (including school closings and cancellation of public events)."McKinsey expects the global economy to skirt a recession under this coronavirus scenario and recover in the second half. Yet annual global economic growth is cut in half to a range of 1%-1.5%. U.S. growth slumps to less than 1% for the year, while Chinese GDP growth slips below 4%.

Likewise, Morgan Stanley's extended-disruption scenario sees U.S. economic growth stalling in Q2 before a second-half recovery. S&P 500 earnings would see another year of roughly 0% growth. This scenario increasingly looks like "the most plausible," Morgan Stanley Chief Investment Officer Mike Wilson wrote in early March.

Despite the economic fallout, the firm's stock market outlook isn't that bad. Wilson sees the stock market remaining in "something of limbo between a bear case and a more bullish state" but poised to rally as confidence grows that the tide has turned.

The typical scenario sketched out by UBS sounds bleak: "We assume infections go up by a factor of 1,000." That could mean more than 100 million coronavirus cases around the world and 1 million in the U.S.

Assuming the coronavirus outbreak "is under control" by midyear, UBS sees the U.S., Europe and Japan falling into recession, then kicking into overdrive by Q4. As long as China doesn't suffer a coronavirus relapse, the global economy would see an accelerating recovery. Global equities could fall 25% from their peaks, before rallying strongly to end down 3% for the year, UBS says.

Before Friday's bounce, the Dow Jones, S&P 500 and Nasdaq composite had already fallen more than 25% from their all-time highs. One risk of recovery would be an insufficient fiscal response. A spike in layoffs by coronavirus-hit industries could damage consumer prospects, leading to a more drawn-out economic and stock market recovery. And while politics has faded as a concern in recent days, it could return once the Coronavirus abates and Election Day approaches.


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