Coronavirus Selloff Can’t Get Much Worse — Or Can It? ICYMI

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The U.S. market on Thursday dipped into correction territory after the World Health Organization said Wednesday that the coronavirus might hit the U.S. But some on Wall Street say that technical indicators, coupled with stock and bond valuations, say stocks can rise sharply from here.

The S&P 500 fell 2.31% Thursday, while the other major U.S. indexes fell sharply as well. The S&P 500 entered correction territory, falling more than 10% from its all-time high, which it hit a week ago.

Stocks started out Wednesday with a bounce, as some strategists had expected. But a warning that the virus may become a pandemic dealt a blow to sentiment.

Semiconductor analysts say several chipmakers are likely to lower their 2020 revenue and earnings estimates, on the heels of such a report from Apple AAPL in mid-February. One strategist Name? thinks industrials, energy and energy companies could soon do the same. Consumers are staying home, and manufacturing plants are slow to return to production, while some are still halted.

But others on Wall Street think the time to buy is nearing.

An assessment of “historical share-market selloffs and spikes in market volatility during periods with generally healthy economic fundamentals [suggests] that the risk/reward for U.S. stocks is becoming more attractive,” wrote Mark Haefele, UBS’s chief investment officer of global wealth management, in a note.

When the VIX volatility index is above 25 and the Federal Reserve’s loan-officer survey shows that less than 5% of banks are increasing lending standards, stocks tend to bounce shortly after, Haefele says.

Canaccord Genuity Chief Market Strategist Tony Dwyer also said the 45% spike in the VIX seen on Tuesday indicates as a bounce could come soon. 

Haefele added that almost no American banks are tightening lending standards right now. “Equity-market returns over the next six months have been over 15%,” with this combination of volatility and banking standards, Haefele said.

This also jibes with Goldman Sachs strategist David Kostin’s remarks.

Kostin is maintaining his 2020 price target on the S&P 500 of 3,440, as the coronavirus is still expected to shock global economic growth only for the first half, with growth resuming in the second half.

That target reflects 12% upside from here.

Kostin did lower his earnings-per-share estimate for the S&P 500 to $165 from $174, which means no gain over 2019. But “lower bond yields offset lower earnings,” he said.

He pointed out that with the 10-year treasury bond yielding 1.32% and the average forward one-year price-to-earnings multiple on the S&P 500 falling to almost 17, the equity risk premium is now above 4%.

That’s the excess rate of return expected in stocks compared with the 10-year treasury yield. Historically, that premium should be 3% or less.

Even if Kostin is ultimately too pessimistic and earnings estimates for 2020 remain at 178, a 3% equity risk premium would indicate an S&P 500 Index much higher than it is now.

On the other hand, if the U.S. were to go into recession in 2020, history says earnings for the year could contract 10%, Kostin’s charts show. That would be a major negative for stocks.

UBS also said, “While we are not trying to call the bottom of the market, past experience suggests this is a good time to invest in U.S. stocks.”

As far as volatility, the virus is a threat to corporate fundamentals and Jim Carney, Founder of Parplus Partners, a volatility trading hedge fund, says “don’t bet against volatility.” 

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