As the reaction to the coronavirus starts to have an impact on consumer and business spending, the expectation of 2020 S&P 500 earnings are falling, and no one has a good handle on exactly what the impact will be. “I don’t know” is not an answer the equity markets like to hear, but that is the best answer at the moment. Hence, the dramatic volatility of the past few weeks.
There are a few things we do know. First, when the medical world does come up with a treatment and vaccine for COVID-19, we will have lower interest rates then when we started. Second, the economy (and the consumer) were relatively strong before concerns of COVID-19 hit the markets. Third, the recent China trade deal, the ratifying by Congress of the USMCA, and some finality with the Brexit situation helped the stock market find new highs just a few weeks ago.
It’s true that some spending that will be “lost” during this panic will not be recovered. Conferences, sporting events, vacations are being cancelled every day. But much of that spending will lead to pent up demand when we have some clarity on how this COVID-19 scare will end. Consumer and business spending should return to normal relatively quickly, and corporate earnings will rebound.
So, how should we determine what is an appropriate value for stocks today?
In normal times, the stock market looks at several factors to determine what an appropriate valuation is. Some factors include overall economic health, corporate earnings, current and expected changes with interest rates, employment and inflation. It could be argued that the most important of these factors is current, and future, corporate earnings. This leads to the biggest problem with determining what an “appropriate valuation” is for the stock market given the current scare.
As we started the year, the expected earnings for the S&P 500 was around $178. Compared with the 2019 S&P 500 earnings of $162.23, corporate earnings were expected to climb almost 10% in 2020. $178, given the lost revenue over the past few weeks, and the expected loss over the coming weeks or months, seems unlikely. The longer that this panic over the COVID-19 continues, the more of that $178 expected earnings will erode. Analysts are currently showing S&P 500 estimates down to $174, and falling. The S&P 500 is currently trading at levels that would estimate earnings to end the year somewhere near $150. If we have some clarity on how and when this scare will end in the next month or two, current valuations will look like a good value. If we do not have any clarity by the end of April, we will most likely be headed a little lower still.
As always, the best defenses you can have in your investment portfolio in volatile times are: 1) an adequately diversified portfolio; 2) an asset allocation which is in line with both your goals and your risk tolerance; 3) some measure of patience and an emotional detachment from your portfolio. Obviously, the last one is the most difficult.
In the end, “I don’t know” is not an answer any equity investor wants to hear. However, “I don’t know” is generally a response to a short-term situation. What ‘we’ do know is the US equity market remains the best place to generate an absolute return due to the strength of the dynamic US economy. Panicked trading always subsides when clearer heads prevail, and the last thing any investor wants to do is answer “I don’t know” when someone asks why they followed the rest of the herd off the proverbial cliff.