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Coronavirus could spiral the stock market down another 30%: Deutsche Bank

Brian Sozzi

Very few investment bank strategist teams have kept it real on the toll the unfolding coronavirus outbreak could further have on equities.

It’s as if the entire Wall Street community has been shell-shocked by the S&P 500 plunging 10% in four sessions last week and the Dow Jones Industrial Average crashing more than 1,000 points in two trading days. Or Apple and Microsoft — two of the hottest trades in the market this past year — being slammed simply because of a tick-up in coronavirus infection totals out of Italy.

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Over the course of one insane week in the markets, carefully modeled annual price targets on companies and major equity indices have been blown to tiny pieces. Who could blame these spreadsheet pushers for being on the fence in their next round of calls, it’s that precarious a situation in the markets. Most strategists are advising people to be patient and stay long in the market even if it goes down another 5%. Haircuts to S&P 500 yearend targets, U.S. GDP growth and individual stock price targets have been slow to come in and not aggressive to the downside when shared with clients via enormous digital research reports.

That is why I found a fresh 14-page note dropped into my email box Monday afternoon from Deutsche Bank so refreshing. It’s one of the first honest assessments of the stock market’s medium-term potential as the coronavirus situation plays out.

“Our central and worse case scenarios see the stock market falling 20% and 30%, respectively, from its previous peak, and bond yields remaining historically depressed for a time,” writes Deutsche Bank’s global head of economic research Peter Hooper.

Explains Hooper:

“On the positive side, there has been a quick flush in equity positioning over the last week (97th percentile to 13th percentile). While we expect positioning to unwind further, the selling pressure should begin to slow.

On the negative side, from a fundamental perspective, the market has simply moved from pricing in earnings growth of more than 20%, which would have easily been the fastest of this cycle, down to now pricing in flat earnings. It is yet to price in any drops in earnings from the expected slowdown in activity. Consequently, we see the selloff as having further to go and in our central scenario we expect equity markets to be down by 20% from their last peak (S&P 500 at 2700).

With the speed of the selloff seeing several technical indicators jump to extremes, many have been asking when and at what levels to buy back in. We note that we are only one week into the selloff. In episodes when vol got elevated historically (>1.5 sigma moves) as has happened, it has taken on average 6-7 weeks for vol to subside. The S&P 500 typically took another 4-5 months after that to recoup losses as investors raise exposure only slowly with trailing vol typically an input into risk management models.

With our central scenario seeing a rebound in macro growth to above trend rates in Q3, we expect equity markets to bottom earlier, during Q2. In the more severe scenario, we see equity markets selling off by more, by around 30% from the peak (S&P 500 2370) corresponding to an average recession selloff.”

Call for hand sanitizers

Meanwhile, one source told me investors should buy a bottle of hand sanitizer, don’t panic and think long-term. I simply shook my head in disbelief. People had their trading accounts shredded last week — surely there is better advice than that. Other folks I have talked with think we are due for a tradeable bounce in equities as central banks come in and slash interest rates (as Federal Reserve chief Jerome Powell signaled on Friday, which has spurred a two-day rally in the markets).

Experts have been advising people to buy hand sanitizers. (AP Photo/Donna McWilliam, File)

By and large, the people up and down the Street I have chatted up on the topic of coronavirus in the past week have downplayed the economic impact to the U.S. and potential for further damage to equities. It’s hard to agree with that when CEOs are telling me — privately and on-air — their businesses in the U.S. and abroad are being hurt by the coronavirus. The economic impact is real, it’s far from fluid as corporate press releases on the matter would suggest and Wall Street best wake up to all of this and prepare clients for a more reasonable short-term outlook for equities.

Buying hand sanitizer and staying disengaged with your portfolio is the last thing one should be doing right now (nothing wrong with stocking up on hand sanitizer, however).

Deutsche Bank’s report doesn’t mention hand sanitizer anywhere. Thank you for an honest assessment, Cooper.

Brian Sozzi is an editor-at-large and co-anchor of The First Trade at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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