By: Dividend Sensei
In part one of this series, I showed how the US is, for now ignoring the coronavirus spreading uncontrollably through our population. That’s exactly what we did in January and February until the rising death toll was too much for us to bear. So then this happened.
The S&P 500 plunged a remarkable 34% in just four weeks, the fastest bear market in US history. Fortunately, it’s unlikely that we will face another 34% plunge in the coming months unless we really screw the pooch as we did at the start of this pandemic.
So now let’s take a look at what investors care about, how bad could the market react to a potential surge in daily cases and deaths to as much as 200K and 8K per day, respectively, and a possible second recession.
The Good News Is That The Second Recession, If It Happens, Is Likely To Be A LOT Milder Than The First
Economists have already weighed in on what they think of Europe’s new partial lockdown plans. Here is the list I compiled from news reports about which European countries were locking down again.
- Czechia (the Czech Republic changed its name a few years ago)
Most of these are four-week lockdowns, though Belgium is going for six weeks. Most of these are not full lockdowns with all non-essential businesses closed (though France, Belgium, and the UK are). Are the people of Europe happy about this? Absolutely not. In Spain and Italy, police are dealing with rioters who are outraged over more lockdowns. What kind of economic damage are economists projecting for Europe over this second wave of less restrictive lockdowns? -4% GDP growth in France in Q4 and -1% in Germany. In the US, where no official lockdowns are expected, the probability of a double-dip recession, which itself would likely be a 1% to 3% decline, are estimated at 20% to 25%. Now, as I showed in my first article if things get bad enough, we might have no choice but to lockdown April style, resulting in far more serious economic damage. However, that likely won’t happen until the 117th Congress arrives in DC on January 3rd, and is willing to support another national lockdown with major stimulus. Until January the US is in “hope and pray” mode. Hope and prayer are not effective investment or risk management strategies but you know what are? Facts and sound risk management.
Here’s How Bad Economists Think The Stock Market Might Crash During This Pandemic
(Source: JPMorgan Asset Management)
Last week I explained why Morgan Stanley, one of the blue-chip economists famed for its accuracy, predicted a 10% correction was the most likely outcome of this third wave of the pandemic. JPMorgan, another one of the blue-chip consensus economists, one of the 16 most accurate out of 45 tracked by MarketWatch, thinks that if we get a double-dip recession, stocks might fall a total of 22% from their recent peak. That would equate to about a 15% decline from here.
Compared to the 34% one month plunge we witnessed in March, this is a very mild bear market we’re talking about. In fact, it’s on par with the 20% peak decline suffered during the Gulf War recession of 1990. Is it possible that both JPMorgan and Morgan Stanley are wrong and stocks might end up going over a cliff? Absolutely. As of October 30th, the S&P 500 was 25% historically overvalued, compared to about 18% overvalued on February 19th, before stocks fell 34% during the fastest bear market in history. BUT there are important differences between March 2020 and November 2020.
- in March we had a global margin call in which large institutions were forced to sell everything to meet margin calls
- gold, treasury bonds, blue-chip stocks (like Lowe’s), all were sold with wild abandon by forced sellers desperate to prevent bankruptcy
- the market bottomed the same day the Fed swore that it would do “whatever it takes” to prevent another financial crisis
Now don’t get me wrong, I’m not one of the “Fed Put” crowd who thinks that it’s safe to pay 24X earnings for the S&P 500 because the Fed won’t’ let stocks fall significantly. However, the Fed absolutely would step in with increased asset purchases, primarily through mortgage-backed securities and US treasury bonds, if the credit markets started to get scared about an out of control pandemic and a crashing stock market.
That’s not because the Fed directly cares about whether stocks are going up or down. But the Fed cares deeply about the smooth functioning of credit markets and if the risks of another severe recession were rising quickly, then the Fed would want to calm the debt markets. That might include more junk bond buying. On March 23rd a major reason the market bottomed when the Fed stepped in with “QE Infinity” was not that the Fed promised to buy $120 billion worth of US treasuries and CMBS. It was the pledge to buy as many junk bond ETFs as necessary to ensure that even low credit quality companies survive this pandemic that got Wall Street into a hyper-bullish mood. In other words, I consider JPMorgan’s estimate of a 22% peak decline in stocks, even if daily cases are 200K per day, and the daily death toll is well over 3K, to be reasonable. But could I and all the blue-chip economists be wrong? What if stocks were to fall 40%, 45%, or even 55% as they did in the Great Recession? Well, here’s the easiest, safest, and most effective way to protect your nest egg from such a low probability but certainly possible stock market crash.