Oh no. Traders work during the opening bell at the New York Stock Exchange on March 5, 2020 after … [+]
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The coronavirus looks set to clobber President Trump’s stock market, and with it, potentially, his chances of winning re-election. MSCI’s stress testing of U.S. securities under the influence of the COVID-19 coronavirus points to a further 22% correction in U.S. equities.
Read ‘em and weep here.
Their inhouse models assume a two percentage point short term decline on a chart measuring economic output. If they hit that two percent mark, and MSCI analysts led by executive direction for risk management research, Thomas Verbraken, think the odds are very high that they do, then the S&P 500 drops another 22%. It’s already down 6.2% year-to-date, so a 14% drop would take it into bear territory.
This is the worst case scenario, though it is a scenario that many market participants are now assuming to be a base case. They are moving to cash, or safe havens like Treasury bonds, pushing yield to less than 1%.
A bear market doesn’t have to last long, of course. But investors have no idea whether China’s outbreak numbers are right — showing a marked decrease in new infections and more recoveries now than total patients; whether the other top countries with outbreaks will see China-like numbers in the tens of thousands; or whether major economic engines in the U.S. will be placed on lockdown orders.
Already people are choosing not to travel. Consumer sentiment, a positive driver for the U.S. economy, is about to take a hit. No one knows how long consumers will stay on hold.
The mysterious and easily spread COVID-19 has now spread to over 70 countries. Many equity markets have recorded their worst short-term losses since 2008 when the bottom fell out of the U.S. housing market.
How much further could markets drop? The answer depends on economic growth expectations — expectations everyone is lowering — and the degree of risk aversion by consumers afraid of catching the disease.
Investors preparing for the worst. (Photo by JOHANNES EISELE/AFP via Getty Images)
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MSCI’s stress test on a 60% equity/40% bond model portfolio shows it could lose approximately 12% and global equities could lose slightly less than 20% while Treasury bonds could gain 6%, offsetting some of the equity losses.
Both corporate investment-grade and high-yield bonds could suffer market-value losses as well. As of the end of trading on March 3, this hypothetical portfolio could drop another 7%, MSCI says.
Lewis Alexander,the chief U.S. economist for Nomura, thinks the worst is yet to come.
Asian equities are quite close to pricing in a ‘Mama-bear’ case scenario, he says.
In Nomura’s new base case, China first quarter annualized GDP growth rate is 0% and for the world it is now 0.9%. Nomura expects a V-shaped global recovery in the second quarter in their base case, and a “U” shaped one in their bad case scenario. It’s an “L” in their new severe scenario, Nomura analysts including Alexander wrote in a 64-page report on the coronavirus published on Thursday.
For the U.S. in particular, a wider and more prolonged outbreak will lead to a material decline in aggregate demand. In this “bad” case scenario, Alexander expects a substantial portion of the labor force to miss work for some time.
In a “severe” case scenario, Nomura assumes a global pandemic that has an economic impact at roughly half the magnitude of the 1918-19 flu pandemic, reducing real GDP by roughly 2.2% in the U.S., meaning: recession.
If the global economy suffers only short-term pain, the market could bounce back once the shockwave of uncertainty dissipates, according to MSCI analysts.
But if long-term growth — and as a result, corporate earnings — took on a lower trajectory due to a pandemic, the market impact could be felt over a much longer period.
How long? Try 10 years.
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By 2030, their model shows that the cumulative impact on U.S. equity could improve to -3% (from -22%) with only a short-term shock, but could rebound to only -10% with both short- and long-term shocks based on where the S&P 500 is today.
In other words, this is a disaster.
The global spread of COVID-19 is already affecting global growth.
Disruptions in the global supply chain and decreased consumption affect corporate earnings, and investors bail on those companies.
Combined supply and demand shocks could lead to a severe short-term decrease in GDP growth in the first half of the year.
The good news is that despite MSCI’s worse case outlook, it is not clear how long the effects of the coronavirus last. SARS lasted 8 months and hasn’t been around since. If the COVID-19 coronavirus lasted that long, it would take us out to August, likely canceling the summer Olympics in Japan.
Lastly, a sustained crisis could also lead to persistent changes in global supply chains, contributing to a partial reversal of global trade out of China.