Uncertainties continue to multiply over the coronavirus outbreak. U.S. investors saw stock values plunge nearly 20% in the past three weeks. Cases of COVID-19, the new coronavirus, are proliferating outside China; at last count, the Centers for Disease Control and Prevention identified 647 cases in 36 U.S. states. To add to the bedlam, during the past weekend a price war broke out between Saudi Arabia and Russia, leading to a 25% fall in oil prices. Question marks hover over its potential impact on the fortunes of energy producers.
These factors whiplashed U.S. markets this week, even as global stocks took a beating for similar reasons. Monday, March 9, saw a worldwide rout across markets, with values dropping in a precipitous one-day plunge reminiscent of the financial crisis a decade ago. By Tuesday, March 10, as the Financial Times noted, “Global markets stabilized from heavy losses as investors welcomed signs that policymakers would launch significant stimulus measures to soften the economic blow from the coronavirus outbreak.” Though European markets recovered slightly that day, investors were still nervous about the nationwide lockdown in Italy, as that country sought to contain its COVID-19 crisis.
So what lies in store for U.S. and global markets in the weeks and months ahead? Will the world economy sink into a recession? If so, will it be short and sharp — as some economists have predicted — or will we have to contend with a deeper, more protracted downturn? Under either scenario, how should investors respond? Should they “buy the dip,” as investment gurus often recommend? Or should they batten down the hatches and lie low until the storms have passed?
Wharton finance professor Jeremy Siegel and Moody’s Analytics chief economist Mark Zandi discussed these issues and more on the Wharton Business Daily show on Sirius XM. (Listen to the full podcast at the top of this page.) The key takeaways: First, Siegel and Zandi believe the U.S. will probably be unable to avoid a recession. Second, more stock market price corrections may occur, possibly heading into bear-market territory, where prices fall by 20% or more. Third, more interest rate cuts are likely from the Federal Reserve. Fourth, stalled hiring and layoffs could worsen unemployment to a point where the recession could grow severe. Siegel and Zandi also offered advice to investors on how they could respond.
Major stock indices — the Dow, Nasdaq and the S&P 500 — have shed some 18% in value since mid-February. Investors chasing safety thronged 10-year Treasuries, dragging yields down as they expected more interest rate cuts and offloaded corporate bonds, especially those of companies in travel and energy. Earlier last week, the Federal Reserve tried to boost the morale of investors with an interest rate cut of a half a percentage point, but that brought limited cheer to the stock markets, as did the results of the Super Tuesday Democratic primaries. Central banks in Canada, Australia and elsewhere also cut interest rates, and G-7 finance leaders explored possibilities of coordinated actions in a conference call.
In order to contain the impact of the coronavirus crisis, Siegel and Zandi believe that governments should offer bridge loans and other forms of aid to small businesses; widen the unemployment insurance safety net; and maybe temporarily cut payroll taxes to give consumers more spending power. President Donald Trump said on Monday that he would work with Congress on tax cuts and other measures.
“We could have a 20% decline in earnings this year, which would be dramatic, and of a recession magnitude.” –Jeremy Siegel
According to Siegel, “earnings [at companies will] be dramatically affected this year” as they grapple with declines in revenues and cost pressures. “We could have a 20% decline in earnings this year, which would be dramatic, and of a recession magnitude.” A recession is informally defined as two consecutive quarters of declining real economic activity, he noted. However, equity analysts “are always slow to put down earnings because they concentrate on micro factors,” Siegel noted. “They concentrate on firms. They are not really geared to try to project what’s going to happen [to the broader economy].”
Zandi said the stock markets “haven’t fully discounted … the possibility of a recession. But they’re on their way. You can see that in the equity market, and even more clearly in the bond market. Now 10-year Treasury yields are at record lows and falling. That’s a pretty clear window to what investors are thinking. If the pandemic is comparable to what the CDC seems to be suggesting will happen, it will be tough to avoid a recession.” The epidemic has resulted in closures of establishments such as schools and daycare centers, disrupted businesses and adversely affected their travel plans, he said.
The good news is, if a recession were to occur, the U.S. economy will enter it from a position of strength, said Siegel. As a case in point, he pointed to the latest employment report, which revealed a gain of 273,000 jobs in February, with the unemployment rate holding steady at 3.5%. “If a patient is going to get sick, what the doctors say is the most important thing is he goes into that sickness being healthy,” Siegel noted. “That will mean that he or she will recover the fastest. That is exactly what we see in the U.S. economy. The U.S. economy is going to receive bad bumps. There’s no question about it. But the fact that we are going into that as healthy as we can be is a very strong positive.”
Employment gains have been strong in the past two months — 225,000 jobs were added in January — but they have been “juiced” by mild weather and hiring by the Census Bureau, Zandi said. The jobs gains were disappointing in December at 125,000, to put that in perspective. “If you abstract from the vagaries of the data, they were probably running around 125,000-150,000 per month,” he said. Job gains have ranged from 128,000 to 145,000 in the previous months, barring a jump to 164,000 jobs in November, according to Bureau of Labor Statistics data. “An employment gain of 125,000-150,000 isn’t bad … and that’s consistent with stable unemployment,” he said.
Still, if monthly employment gains fall below 100,000 on a consistent basis, unemployment will start to rise, Zandi warned. “Once unemployment starts to rise, even from a very low level, that’s the fodder for recession. People can sense that and they will pull back. Businesses will see that and they [too] will pull back. That’s how you get into a vicious cycle known as a recession. So, I don’t think we’re too far away from an environment where a recession becomes a real threat.”
“If the pandemic is comparable to what the CDC seems to be suggesting will happen, it will be tough to avoid a recession.” –Mark Zandi
Stock Market Outlook
According to Siegel, whenever investors consider long-term assets, they need to realize that “more than 90% of the value of stocks is dependent on profits more than 12 months out into the future.” He added that earnings reports may be “very bad” in this year’s second quarter and also perhaps in the remaining two quarters of the year, but they could change for the better after that. He noted that according to experts, viruses are self-limiting. “I’m looking at a pretty bad 2020, but I’m [also] looking for a bounce-back in 2021.”
According to Siegel, stock prices were “already too high” in the weeks before the coronavirus outbreak began spreading worldwide. “We were riding too high in that momentum-driven market.” Estimates he made earlier this year about corporate earnings growing 5% in 2020 are no longer valid, he explained. “That was without the virus. Right now we could get minus 20%. We could get minus 30%. We have not had a bear market since the Crash of 1929, which is defined as a 20% [decline from recent highs]. We could definitely have that. Would that shock me? Not in the least.”
To counter the impact of the coronavirus crisis, the Fed’s rate cut was “the right thing to do,” said Seigel. “Hundreds of billions of dollars of loans are pegged to the Fed’s prime rates, Libor rates, [and also] all sorts of business rates.” He noted that the rate cut of 50 basis points would translate into a proportionate fall in interest payments for small businesses such as restaurants. “It will help. It’ll give them a few thousand dollars more in these months.” He expects more interest rate cuts from the Fed in the future.
Zandi agreed that the rate cut was an appropriate step. “[But] I’m not sure about the execution,” he said. In hindsight, it wasn’t as effective as expected, he noted. The stock markets seemed to give it fleeting attention, and then they continued their free fall. “[It didn’t] go as well as I’m sure Fed officials had hoped. The market sold off significantly. The Fed’s intent was to shore up confidence in the U.S. and it did the opposite. They kind of spooked investors, so if they had it to do it over again, maybe they do it a little bit differently.” Still, “the Fed doesn’t have a whole lot of room to maneuver here, given where rates are,” said Zandi. The low rates give the Fed little wiggle room to exert more influence with rate cuts.
Given those limitations of monetary policy, the Trump administration should use fiscal policy to prime the pump, according to Zandi and Siegel. “[For instance], stepping up Small Business Administration bridge loans to small businesses that might have cash flow problems could very well happen,” said Siegel. Added Zandi: “It’s about cash flow. Many small businesses don’t have those resources to weather a storm that lasts for more than a week or two.”
“The U.S. economy is going to receive bad bumps…. But the fact that we are going into that as healthy as we can be is a very strong positive.” –Jeremy Siegel
Siegel also called for “an emergency step [of] a tax cut.” That would leave more cash in the hands of small businesses and workers who may not get paid or get tips or be laid off. “I think despite the politics of the situation, both Democrats and Republicans are ready to do that,” he said. “We already have some sort of a fiscal stimulus package that the Senate is looking at from the House. They’ve stopped this bickering back and forth. We may have to look for an emergency tax cut that that’ll give more cash to consumers.”
Zandi agreed. “A temporary payroll tax holiday is a tried and true fiscal stimulus,” he said. “It gets money to lower middle-income households so quickly. It shows up right in their paychecks.” Among the other measures he suggested was to expand unemployment insurance benefits, since many people may not be able to get to work.
Companies that need the most support include those in transportation and distribution, because “they are on the front lines of the hit to global trade” that the coronavirus epidemic is creating, said Zandi. Next in line would be the travel, hospitality and leisure industries, he added. Beyond that, almost every industry in areas where communities are shut down through quarantine or declared as disaster areas will be affected, he noted.
What Should Investors Do?
As stock prices seem low now, should investors try and pick up some on the cheap? Zandi and Siegel had different perspectives on that question. “Most people shouldn’t look [at the market now],” said Zandi. “They should have a long-term investment horizon of five or 10 years. These ups and downs are not relevant. They should just ignore it.”
Investors who are in their fifties and sixties, who are approaching retirement, should wait until the volatility settles down, said Zandi. “Then, it would be a good time to evaluate how invested you are in the stock market, given the volatility that exists there, because you’ll need that money for retirement sooner rather than later. Your horizon isn’t long enough to be investing a large share of your portfolio in stocks.” Zandi also advised investors to avoid trying to re-allocate their portfolios, trying to balance equities with safer asset classes. “[Do not do that] at a time like this,” he said. “The markets are very volatile, and the S&P is already down almost 20%. I would caution [investors] not to do anything rash. This is a wake-up call for those who don’t like this kind of volatility and can’t live through it. When the dust settles, you can find investments that are more suited to your willingness to take risks.”
“Buying stocks at reasonable levels relative to history has always paid off for the long-term investor.” –Jeremy Siegel
According to Siegel, “We all know which industries are going to suffer. I do want to warn people [to] get out of those in the stock market. Even though [those industries are] going to be hit, a lot of that hit has already been discounted in the prices.” He didn’t rule out stock prices in those industries declining another 5% or 6%. If people invest now in those industries, they will “most likely be rewarded a year from now with decent returns,” he added.
To be sure, uncertainty clouds the investment outlook. “Nobody knows how much earnings will be affected in 2020,” Siegel said. But beyond that, one might “assume that 2021 earnings will rebound to the same levels we saw in 2019. But virtually no one can buy at the bottom. Buying stocks at reasonable levels relative to history has always paid off for the long-term investor.”
The long-term prospects may well be why Chinese stock markets seem to be shrugging off the coronavirus impact and moving towards higher prices. Siegel noted that the Shanghai Composite Index is now higher than it was last November before China had had a single case of coronavirus. “How can that be? They’ve been in lockdown. They’re going to have a recession,” he said. But even as China may be staring at a contraction in its GDP, the investors driving up the Shanghai index may have decided they are going “to look further out,” he said. “The experts say, and we know through experience that these viruses – they have their big impact, and then they’re self-limiting. And we bounce back in 2021.”