(Bloomberg) -- They bought the rumor, sold the news, and now investors are back to their real obsession: imagining what a recession looks like in equities. It’s not a pretty picture.
Making it worse are feedback loops, many of them emanating from markets themselves. Headlines hit, shares tank, nerves fray, travel is canceled. Shares fall some more. And while dynamics like those are always what derail rallies, it makes the challenge of visualizing the future no easier or less urgent.
“Equities have a tendency to price in the worst-case scenario,” Gina Martin Adams, an analyst with Bloomberg Intelligence, said on Bloomberg Television, speaking before doubt set in that the Federal Reserve’s emergency stimulus would save the economy. “The worst-case scenario is a recession.”
Worst-case scenarios (which Martin Adams doesn’t foresee) are easy to arrive at when so much is happening in a vacuum. That’s the case now, when economic data has yet to incorporate the virus’s impact. So while the Dow Jones Industrial Average has posted three moves of a thousand points each since the start of last week, speculation is all anyone has to go on.
Equities dropped for the eighth time in nine days Tuesday, retracing two-thirds of Monday’s rally, as investors reconsidered the efficacy of Federal Reserve efforts to stimulate the economy. Selling took hold as Chairman Jerome Powell acknowledged even a half-point rate cut is insufficient to solve the myriad economic and health risks posed by the coronavirus.
Futures signaled more pain ahead, with contracts on the S&P 500 down 0.3% as of 6:22 p.m. in New York.
Earnings among S&P 500 companies are projected by analysts to rise about 7% in 2020, but few investors expect that to happen. A number of companies have already warned the virus will have a material impact on their bottom lines. Not many have specified what.
Because of that uncertainty, estimates for the overall toll on stocks range from the subdued to the extreme. To get a sense of how far stocks can plummet, Bespoke Investment Group mapped out a scenario in which the coronavirus causes earnings per share to shrink by 20% temporarily, with multiples contracting to 16. That would translate to a more than 40% decline in the S&P 500 Index from its mid-February record.
“That seems like a reasonable bear case,” said George Pearkes, a macro strategist at Bespoke. “If so, we’re roughly one-third of the way there.”
Analysts at Citigroup Inc. cut their full-year earnings forecast, citing supply chain issues, demand weakness and lower commodity prices. U.S. companies will see earnings of $164.25 in 2020, down from a previous estimate of $174.25, according to Tobias Levkovich, chief U.S. equity strategist at the bank.
“The bigger unknown issue is could COVID-19 trigger a global recession?,” he wrote in a note. “That would mean profits decline near 25% and equity markets fall similarly as stocks typically track earnings given past patterns when downturns occurred.”
With the S&P down as much as 13.5% from its recent high, investors might already be pricing in risks, according to Levkovich. But should a recession materialize due to the virus outbreak, the firm projects it would need to cut its 2020 EPS projection by another $30, he said. Applying a multiple of 18-times earnings would generate a 2,400 level for the index, implying a 20% drop from Monday’s levels. The firm cautions investors to stay on the sidelines for now.
It’s the latest in a string of pronouncement from Wall Street strategists, who have rushed to map out potential scenarios. Strategists at Goldman Sachs last week predicted zero profit growth for the year, saying that a looming recession could mean the S&P ends the year down 28% from its recent February high.
Dire predictions about an economic fallout have been piling up and after a key gauge of U.S. manufacturing retreated to near-stagnation in February, more investors are starting to question just how well the economy can hold up.
Read more: Virus Pushes the Global Economy Closer to a Contraction
A Federal Bank of New York gauge currently puts the odds of a U.S. recession over the next year near 25%, the highest such reading since 2008. The Organisation for Economic Cooperation and Development said global growth will sink to levels not seen in more than a decade as the outbreak dents demand and supply. It cut its full-year forecast to 2.4% from 2.9%, which would be the weakest rate since 2009.
“The fear of a recession is there in the back of the market’s mind,” said Anik Sen, global head of equities at PineBridge Investments, which has about $101 billion in assets under management. “Does it worry investors? Yes, for the short-term. That’s why the central banks are standing ready to provide liquidity and more stimulus if needed.”
Group of Seven finance ministers and central bankers spoke this morning before the Fed made its move, promising again to do what is needed to offset the economic effects of the virus. Traders weren’t impressed and are now betting that the Fed will have to do more, with the futures markets pricing additional easing later this year. Calls for fiscal stimulus have also picked up.
“The markets worry with intra-meeting Fed rate cuts, what does the Fed know that we don’t know?” John Augustine, chief investment officer at Huntington Private Bank, said. “The stock market will remain volatile until coronavirus cases peak. We’re in unprecedented territory for the Fed to act like this. This is likely going to lead to further volatility in financial markets.”
--With assistance from Elena Popina and Claire Ballentine.
To contact the reporters on this story: Vildana Hajric in New York at vhajric1@bloomberg.net;Luke Kawa in New York at lkawa@bloomberg.net
To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Chris Nagi
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