Review the latest portfolio strategy commentary from Mike Gibbs, managing director of Equity Portfolio & Technical Strategy.
The 30% market selloff since the S&P 500 hit a peak exactly one month ago on February 19th has been historic (to say the least). With the global economy screeching to a halt, and the number of new coronavirus cases increasing every day, global equities are understandably on the defensive. The economic toll has worsened dramatically over the past week, leading us to lower our S&P 500 base case earnings estimate to $155. This reflects -5% earnings growth for the full year on a -0.5% contraction in GDP for 2020, with the assumption that the number of new coronavirus cases plateaus around Memorial Day- leaving enough time for the economy to directionally show signs of improvement into the Fall and back half of the year. Admittedly, it is nearly impossible to have a great deal of confidence in economic and fundamental assumptions at this point with the duration of the coronavirus pandemic so uncertain. From a valuation standpoint, the S&P 500 now trades at ~15x P/E (long term average is 16.5x). It is important to remember that the stock market is a forward-looking mechanism- meaning valuation multiples will start to rise far before economic data and corporate profits find a trough. Stocks have historically bottomed 4 months prior to recession end and 4-6 months before earnings trough. For example, the credit crisis P/E bottomed at 10x, and expanded to 17x by the time earnings troughed. For this reason, we maintain a 19.5x P/E year-end base case assumption as the market eventually discounts the eventual recovery (results in a S&P 500 base case target of ~3000). In a bear case scenario of -3% GDP for the full year (credit crisis saw -2.5% GDP contraction for full year), we could see S&P 500 earnings hit by -20% y/y, taking full year earnings to $130.
So while we believe this will prove to be a good buying opportunity for the long term, what gets us out of decline in the short term? The Fed is doing a good job, helping credit markets- though we are still watching for corporate credit spreads to find a peak. Fiscal programs are needed, and will be coming (likely over $1T) as the economic impact of the coronavirus pandemic will be big. Most importantly though is the spread of the virus. The spread and economic impact go hand-in-hand. Raymond James Health Care Policy analyst Chris Meekins puts out 4 scenarios with Scenario 1 and 2 having the highest odds (Link HERE). The “Stop Everything” scenario 1 could see a peak in new cases by approximately late April, if we can implement this soon. In this scenario, equities may be near the low now. The “Eventually We Get It” Scenario 2 is if the country takes longer to implement Scenario 1, with a potential peak in new cases by Memorial Day. In this scenario, 2100-2400 on the S&P 500 looks like potential support (with a bias toward 2100). If we follow one of these, the economy can start to directionally show signs of recovery by the Fall and into back half of the year. In sum, we view this as a buying opportunity for long term investors, but would use partial positions (patiently accumulate) with the number of new cases still accelerating in the short term.
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