Markets Are in Free Fall, but Don't Give in to Panic
Well, that escalated quickly. Our portfolio was at its all-time high a little more than four weeks ago. Almost every position was at or near an all-time high. Most investors can probably say something similar.
Today, the average stock in our portfolio is down almost 32% from its respective 52-week high. The market has been upended in a very short amount of time due to the coronavirus. The longest bull market in history came to a thundering and sudden end in 19 trading sessions. How does that happen?
The coronavirus has caused major disruptions to the economy
Monday saw the Dow Jones Industrial Average shed another 3,000 points and all of the major indexes were down at least 12% on the day. The Dow is now 30% below its all-time high, while the S&P 500 and Nasdaq indexes are down 28% from their peaks.
The sheer velocity of the declines has been incredible to behold. Investors had 10-plus years of a bull market, and that was undone in less than a month.
The coronavirus, which seemed so far away in China a month ago, finally made it to the U.S. For quite some time, the federal government acted as if the virus was contained or not a big deal. But we see now that it is. The Centers for Disease Control and Prevention has repeatedly said the virus can transfer between people in close proximity.
Monday afternoon saw the president urging people to avoid large groups and to stop dining at restaurants or bars. Prior to this, multiple state governors had closed schools in an attempt to slow down the transmission of the virus. After citizens didn't take the advice of doctors, multiple states have now closed bars and restaurants and banned large gatherings. Several states have even postponed their primary elections. Professional sports leagues like the NHL and NBA have suspended their seasons, while the NCAA canceled its men's and women's basketball tournaments. Major League Baseball has suspended spring training and postponed opening bay.
Predisent Trump himself, who had previously dismissed the coronavirus as a media-driven hoax or not something that will hit the U.S. hard, now believes the outbreak may not be under control until mid-summer. Experts believe the best way to prevent the spread of the coronavirus is for everyone who can to practice social distancing.
Make no mistake about it, this is going to greatly impact not only the U.S. economy, but economies around the world. Consumer spending is estimated to account for approximately two-thirds of the economy of the U.S. Now that the consumer is being told to stay home, the economy is likely to grind to a halt.
All of this means that it is nearly impossible for companies or analysts to predict what earnings will look like going forward. Multiple companies have already pulled their guidance for the year. Investors won't be able to attach a valuation to the market or individual stocks without having some idea of what the "earnings" portion of the price-earnings ratio looks like.
Sure, one could use last year's earnings per share figures, but given the current backdrop, does anyone think results for this year are going to look anything like the ones for 2019? For example, McDonald's (NYSE:MCD) had been expected to produce earnings of $8.52 per share for 2020. I find it difficult to believe that the company, a Dividend Aristocrat and a name I consider to be a core holding, will be able to grow earnings per share 9% from last year's total as expected given that restaurants in many states are now switching to drive-thru and delivery only. Earnings estimates are going to need to come down as the economy slows.
Exacerbating the situation is that the markets were already priced for perfection. The S&P 500 had a price-earnings ratio north of 25 just last month. Introducing this much uncertainty around earnings has led to investors exiting the market in droves in order to preserve what gains they have remaining.
What investors should and shouldn't do
While things look grim at least in the short term, long-term investors, or those with many years until retirement, should resist the urge to sell their holdings simply because of the decline. It can be easy to throw your hands up and say "enough." Some investors will likely be concerned with persevering the capital they still have invested.
The current environment is unlike when the dotcom bubble burst, where companies with little to no earnings were reaching undeserved valuations, or the Great Recession, where there was systemic risk to the global financial system. This is a global issue that will only be solved through decisive government action and, hopefully, a vaccine down the road.
Fear about markets is understandable, but selling out now means locking in those losses forever. Those with several years until retirement will most likely be best served by staying invested. Even those who are in retirement should pause before hitting the sell button.
If the investor is fortunate enough to live off dividends, then they should definitely consider holding here. This is doubly true if the stocks they are holding have managed to pay and raise dividends through multiple recessions.
Companies like Johnson & Johnson (NYSE:JNJ), which I believe should be one of the first dividend growth stocks investors should own, has nearly six decades of annual increases. The company is well-diversified and likely to withstand the current business backdrop quite well. This safe and reliable stock is only about 15% of its 52-week high, a much better performance compared to the indexes.
Here are some other names and sectors that I think can be bought right now.
Investors should take advantage of the dip in sectors that are fairly stable and recession-proof. Utility companies offer reliable earnings results and most offer a high yield. We added to Southern Co. (SO) earlier in the month, though today's investor can receive an even better yield than we acquired.
Also looking attractive are AT&T (NYSE:T) and Verizon (NYSE:VZ). These telecommunication giants offer a yield vastly superior to that of the average S&P 500 stock. AT&T's yield is almost three times that of the market index, while Verizon's is double. Both companies traded with a low price-earnings ratio prior to the meltdown in the markets and both have stable free cash flow. People are likely to maintain their smartphones as a way to stay connected to the outside world as they practice social distancing. AT&T is a full position for us, but Verizon's yield and relative safety will likely cause us to purchase shares of the company as soon as capital is available to be deployed.
CVS Health Corp. (NYSE:CVS) is another name that can be bought here. Consumers will continue to need their prescriptions and pantry items that the chain offers. The company has the highest market share of prescriptions in the country. CVS Health paused its dividend as it digested its acquisition of Aetna, but has a generous yield and is well covered by free cash flow.
AbbVie (NYSE:ABBV) and Merck (NYSE:MRK) are also two solid pharmaceutical companies to consider. AbbVie is very reliant on Humira sales for now, but the company has multiple products that are generating high growth rates and the stock sports a yield above 6%. Merck's Keytruda has become one of the best-selling drugs on the market, yet makes up only about a quarter of total sales for the company. This shows that Merck has a diversified business that won't rely on just a single drug. The yield of 3.5% is more than 100 basis points above that of the S&P 500.
Final thoughts
Markets remain challenging with massive moves to the downside almost every day for the past few weeks. Investors are rightfully nervous about the negative impact that the coronavirus will have on the global economy. Most of the companies that we own are down significantly from their 52-week highs.
Still, this isn't the time to sell unless you need the money in the short term. Investors in retirement living off dividends can enjoy the higher yields that the stocks are producing. Those still years away from their own retirement can use this downturn to acquire companies that have reached levels not seen in years. There are sectors and companies that are likely to navigate the current environment much better than others. Those are the names that we are targeting for purchase.
Author Disclosure: The author is long McDonald's, Johnson & Johnson, AT&T, Verizon, CVS Health and AbbVie.
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This article first appeared on GuruFocus.
