While the Friday Rally Was Incredible, Massive Downside May Still Lie Ahead

Investing

Published: March 16, 2020 7:15 am

Last Updated: March 16, 2020 9:49 am

The rally that took place on Friday, and really caught fire while the U.S. president was holding a press conference with prominent business leaders in attendance, was a welcome sight for weary investors who have watched the market free fall a stunning 26% since February 19.

The problem for itchy trigger finger investors with cash to put to work is that there may be the possibility of even more big-time downside risk until an actual bottom is put in. One reason this may not be the end is that the average bear market wipes about 36% off the S&P 500 and lasts for about seven months, according to data compiled by Dow Jones Market Data. If that held this time, it would put the S&P at about 2,200 sometime around September.

The major problem for stocks is that there is still a tremendous number of unknowns to the overall equation. With the United States and many other countries virtually on lockdown due to the coronavirus pandemic, commerce and industries of all shapes and sizes are bound to suffer.

That means corporate earnings are going to suffer and, depending on how long things go on, this could have a huge impact on earnings, not just for the second quarter, but for the entire year. Across Wall Street, virtually all the firms we cover here at 24/7 Wall St. are lowering price targets on stocks still rated Buy and Outperform.

Another big problem for stocks is the fact that bottoms are rarely put in fast, and the idea of a quick V-shaped recovery and the bull market resuming anytime soon is highly unlikely. The current bear market ended a stunning 11-year bull market, which came out of the ashes of the 2008 collapse. It took six months from the collapse of Lehman Brothers on September 15 of 2008 until that bear market ended, and the recently deceased bull market started on March 9, 2009.

Many across Wall Street are saying that a recession in 2020 is now imminent, when just over a month ago most of the pundits were only handicapping about a 10% chance of one this year. A recession is defined in economics as a business cycle contraction in which there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending. In most countries, it is defined as negative economic growth for two consecutive quarters.

Given that it could take six months or so for the COVID-19 issues to play out, it is possible that gross domestic product for the second and third quarters could come in either minuscule or may actually be negative. With that in mind, it is very positive that the U.S. economy is in such strong shape, especially compared to other countries around the world.

Typically, black swan events like the coronavirus pandemic trigger market sell-offs, and with the stock market trading at obscene multiples in January and early February, that’s all it took for many professionals to say game over, at least for now. Between margin calls and redemptions, it certainly appears that many managers were forced to sell not only stocks but corporate and Treasury bonds. Even gold was being sold off after big previous gains.

One bright light for consumers, though it doesn’t bode well for some smaller energy companies, is the dramatic drop in oil prices. Oil was trading in the low $60s per barrel in early January. West Texas Intermediate closed Friday at a stunning $31.73 a barrel, a massive 50% drop. This literally will be a windfall for consumers, who should see a dramatic drop in gasoline prices at the pump.

In addition, another huge positive for consumers is that mortgage applications jumped 55.4% week over week, thanks to the highest refinance application volumes since 2009. Many feel that mortgage rates could drop to levels seen in 2012 and 2016 or even lower. This is also very positive for entry-level homebuyers looking to escape sky-high rents in big cities. Some on Wall Street are pricing in a 100-basis-point (1%) drop in the federal funds rate when the Federal Reserve governors meet on Wednesday of this week. That would drop the benchmark to the 0.00% to 0.25% level.

Both of these items are also positive when discussing recession as U.S. gross domestic product is 70% personal consumption. If millions of Americans have more money in their pockets, it is possible that flush consumers could indeed help to support consumption to a level that would help to keep us out of recession, but that’s a very big if.

One thing is for sure, especially for investors chomping at the proverbial bit to buy stocks now. It could take months for things to get sorted out, from both the pandemic perspective and the huge pullback in the markets in a very short time. Investors can expect more volatility in the weeks and months ahead, and we also could see some big price moves.

The best plan if you have cash to put to work is to scale buy shares when things take a big leg down, like they did last Thursday. It is very likely that a year from now this will all be in the past and we will have new issues to contend with. History tends to show that, time and time again, markets can bounce back from massive drops, but that rarely, if ever, happens overnight.