Investing

Answers to FAQs about the recent market disruption – Part 2

1. Is the trajectory of coronavirus cases in the US more likely to resemble that of South Korea, where cases appear to be peaking or Italy where the number of new cases continue to climb?

Unfortunately,
US cases appear to be following a similar trajectory to that of Italy. Italy,
on February 23, 2020, had reported 155 cases. Ten days later that number had
climbed to 3,089, and by the end of last week stood at 21,157. Reported cases
in the US stood at 159 on March 5, 2020. Nine days later that number had climbed
to 2,836.1 It is becoming increasingly apparent that the US will
follow Italy’s lead and soon be heading towards a prolonged period of mandated
isolation with large segments of the US economy shut down.

2. What facts
do we know about the coronavirus?

According to a
study of 44,000 cases in China:2

  • 80.9% of the cases are considered
    mild and flu-like in nature.  13.8% of
    the cases are listed as severe and require hospitalization, while 4.7% are
    listed as critical and require intensive care. 
    The potential number of people needing to be hospitalized and to require
    intensive care will potentially be large enough to overwhelm the US healthcare
    system.
  • Most coronavirus sufferers recover,
    but the fatality rate (0.7% in South Korea, 3.9% in China, and 5.0% in Italy)
    is orders of magnitude higher than that of the common flu. (These numbers are
    likely elevated because people who are asymptomatic or only experiencing minor
    symptoms are unlikely to be tested and/or counted).
  • Those aged 60+ are most at risk,
    especially those with existing conditions such as cardiovascular disease,
    diabetes, chronic respiratory disease and high blood pressure.

3. What is
a bad- and even-worse-case scenario for the US equity market?

The US stock market has already declined peak to trough by 29.5%,
with a large majority of stocks in bear market territory.3 Peak to
trough we are now down 29.5% as of market close yesterday. 

Market
bottoming may be a prolonged process and will not likely occur until the number
of new cases appear to be peaking and economic activity begins to stabilize.

Here’s a
framework to think of a bad-case scenario for the broad US equity market:

  • The S&P 500 Index, at its peak on
    February 19, was trading at price to trailing 12-month earnings ratio (P/E) of
    21x.4 The current P/E is 17x.5 In the last 7 recessionary
    bear markets, the price to earnings ratio contracted, on average by 25%6
    which in this instance could result in a P/E of 14x.
  • S&P 500 earnings stood at $165
    per share at the peak of the cycle.7 Earnings could contract by as
    much as 20% in a full-bore global recession, down to roughly $132 per
    share. 
  • Per that framework, we could envision
    a bad to even-worse-case scenario that would the S&P 500 down toward 1,800
    to 2,000.   

4. Why did
the US Federal Reserve (Fed) lower interest rates to zero?  Aren’t they already out of ammunition?

In addition to
fostering maximum sustainable employment, the other prong of the Fed’s dual
mandate is to maintain price stability. Inflation expectations have been
plunging. The Fed had to respond. An independent central bank with the world’s
reserve currency is unlikely to run out of ammunition. The Fed will continue to
massively expand its asset-purchase program ($700 billion in new purchases
announced)8 and will continue to provide emergency liquidity
provisions to the parts of the market in distress. The Fed can’t solve this
problem alone, but we believe investors can rest assured the Fed will act
aggressively to prevent a global financial crisis from occurring.

5. Should
we expect more fiscal stimulus?

Yes. The first
round of stimulus (roughly $50 billion9) is designed to provide
near-term support to workers through paid sick leave and expanded unemployment
benefits and to expand health-care needs, including free coronavirus testing
for those without insurance and expanded Medicaid benefits.  We expect the next round of stimulus to be
substantially larger and to include targeted support for businesses,
communities, and households. 

6. Should I be worried that this will result in the next global
financial crisis?

2008 does not appear to be the right lens for viewing this crisis. This is a very different environment from 2008, when banks globally were significantly over-levered. Banks, heading into this crisis, are better capitalized than they have been in years. Interbank lending rates, like credit spreads, have widened in recent weeks but are still below levels reached during the 2016 market drawdown.10 If there is any type of disruption in the interbank lending or credit markets, then we would expect the Fed to be very aggressive in providing emerging liquidity provisions.    

See Part
1
for more answers to the FAQs we’re hearing from investors and
advisors.

Peak to trough we are now down 29.5% as of market close
yesterday. 

Important
Information

The price-to-earnings ratio, also
known as P/E ratio or P/E, is the ratio of a company’s share (stock) price to
its earnings per share. A trailing P/E uses the company’s actual earnings per
share over the past year, rather that a company’s guidance on future earnings.

Endnotes:

1 Source:
World Health Organization, as of 3/14/20

2 Source: The
Chinese Center for Disease Control and Prevention, as 2/29/20

3 Source:
Bloomberg and Standard & Poor’s, as represented by the S&P 500 Index,
as of 3/16/20

4 Source:
Bloomberg, as of 3/12/20

5 Source:
Bolomberg, as of 3/13/20

6 Source:
Bloomberg, Empirical Research Partners, as of 3/13/20

7 Source:
Bloomberg, as of 3/13/20

8 Source: US
Federal Reserve

9 Source: US
Congress

10 Source: Credit
spreads are represented by the Barclays US High Yield Corporate Bond Option
Adjusted Spread and interbank lending rates are represented by the Federal Funds
Rate Forward Rate Agreement Overnight Index Swaps.

Important information

Index definitions:

The S&P
500
is a stock
market index that measures the stock performance of 500 large companies listed
on stock exchanges in the United States. It is not possible to invest
directly in an index. Past performance is no guarantee of future results.

A credit spread is the difference
between Treasury securities and non-Treasury securities that are identical in
all respects except for quality rating.

The opinions referenced above are
those of the authors as of March 17, 2020. These comments should
not be construed as recommendations, but as an illustration of broader themes.
Forward-looking statements are not guarantees of future results. They involve
risks, uncertainties and assumptions; there can be no assurance that actual
results will not differ materially from expectations.

This does
not constitute a recommendation of any investment strategy or product for a
particular investor. Investors should consult a financial advisor/financial
consultant before making any investment decisions. Invesco does not provide tax
advice. The tax information contained herein is general and is not exhaustive
by nature. Federal and state tax laws are complex and constantly changing.
Investors should always consult their own legal or tax professional for
information concerning their individual situation. The opinions expressed are
those of the authors, are based on current market conditions and are subject to
change without notice. These opinions may differ from those of other Invesco
investment professionals.

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