U.S. stocks parred their gains Friday afternoon, with the S&P 500 up more than 5% in the morning and then only 1.6% by midday.
But more importantly, many on Wall Street are now starting to say this is a bear market to buy, even if there is short-term pain to come. It’s hard to pick the bottom of the market, but the market surely looks to be pricing in a recession on account of shut down economic activity spurred by the Coronavirus.
“Financial markets have appropriately moved to price in a potential U.S. recession on the back of virus/energy shocks,” wrote Mike Wilson, Morgan Stanley’s equity strategist.
Currently, the 10 year treasury yield of 0.94% is below the short-term federal funds rate of just above 1%. Given where the average stock on the S&P 500 is priced relative to earnings, the equity risk premium — a measure of how expected return much stocks yield over the safer 10 year treasury bond — is currently 5.6%. Historically, that risk premium sits at around 3%, but when the market prices in a recession, investors demand a higher premium reward for taking the risk of owning stocks.
“Recession risks are now clearly elevated, and we expect that there will be a hit to U.S. growth,” wrote Columbia Threadneedle Investments head of multi-asset strategy, Anwiti Bahuguna in a note. “The extent of the decline will depend on the severity and duration of the Coronavirus infections.” She thinks two more months demand disruption from the virus would likely mean a recession.
Wilson said, “it is time to start adding to equity risk for longer-term investors, even if modest further downside overshoots are possible in volatile markets.” And the average price-to-earnings ratio on the S&P 500 is 15.3, still just above the 10 year average of 15. Just before a recession, that multiple can fall even further.
Morgan Stanaley’s team of economists, strategists and stock analysts see consumer spend — which has been the last to get hit by the virus — grinding to a halt. The U.S. economy is comprised 70% of consumer spend, so the economy needs the consumer in order to stay growing.
“Movie theaters/entertainment, fast casual dining, and specialty retail are all areas to watch,” Wilson said. “The stimulus effects from a potential payroll tax cut [from Trump] may be dampened in the near term as the things people typically spend a tax cut on, like going out to eat and to the movies, may be unappealing while the virus situation is unresolved.”
The Federal Reserve is injecting a total of several trillions of dollars of cash into the banking system, which is unlikely to get people and businesses moving during the virus’ outbreak, but could pad a recovery. Wilson expects more quantitative easing.
Wilson said banks will likely lend less, as credit falls.
Oil companies may cut capital expenditures, hurting industrial companies’ revenue streams. Occidental OxY has already done so to the tune of 32%.
Morgan Stanley economists see growth in the second quarter of just 0.6% fro 2.1% in the first quarter. Some see negative growth while others see 0% growth, which wold make the economy vulnerable to recession.
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