JP Morgan Calls For A Depression
If you think the U.S. economy is headed for a recession, you should buy stocks. That’s a sentence I never thought I would write. Turns out, stocks have already fallen about 30%. On average, stocks fall 37% in recessions. You don’t have much downside left if this is just a recession. Stocks are falling this week because of depression fears. In other words, if you think this economic weakness will only lead to a recession, you are relatively bullish.
We went from having no recession for 11 years and none on the horizon to the first depression since the 1930s in the span of a few weeks. That’s because the U.S. economy is being shut down. It’s impossible for the economy to grow in Q2. I see no scenario where a recession is avoided.
JP Morgan quantified its call for a depression on Wednesday. Stocks can easily fall 50% if these forecasts come true. This negativity explains why stocks have been falling in the high single digits and low double digits for days on end. The bank expects U.S. GDP to fall 4% in Q1, 14% in Q2, rise 8% in Q3, and rise 4% in Q4. This would be the sharpest decline of our lifetimes. Our economy’s easy quarter over quarter comps allow for 4% Q4 growth. That is -1.9% on a year over year basis.
The firm sees -40.8% Chinese Q1 GDP growth and 57.4% Q2 growth. Europe will see a 22% decline in Q2 and a 45% increase in Q3. Japan will be spared the most as it will only see a 3% decline in Q1 and a 1% decline Q2. This will be a global depression if JP Morgan is correct as the firm sees -12% Q1 global GDP growth and -1.2% growth in Q2. Previous to COVID-19, negative yearly growth seemed very unlikely.
Americans Are Pessimistic
Final University of Michigan consumer sentiment index will show a sharp decline from its preliminary reading. Retail sales are about to implode in March. Gallup survey below shows how much has changed in the past month. Percentage of national adults very or somewhat worried about exposure to coronavirus rose from 36% in the first half of February to 60% in the first half of March. Even 42% of Republicans are concerned.
66% of households with incomes less than $40,000 were concerned. They should be concerned, although, less about the virus and more about the economic ramifications of shutting the economy down. This virus a huge deal worth taking safety measures to prevent. Quarantining will work, but the poor and middle class will suffer huge job losses. If the virus is contained, economic impacts may end up being worse than the virus itself.
2020 Earnings Recession
Bad news is earnings estimates are way too high. They aren’t falling quickly enough. We might see our first example of estimates being missed sharply if they don’t fall further in the next few weeks. Good news is stocks have reflected that weakness already. It will be interesting to get the exact numbers on earnings, but the truth is the market might bottom by the time firms report results. We could see a weird scenario where firms report terrible results and no guidance, but have their stocks rally.
As you can see from the table below, Q1 EPS growth estimates have fallen from -0.55% to -2.56% since the start of the month. This is way too optimistic. Q2 2020 EPS growth estimates have fallen from 3.48% to -0.35%. We could see Q2 EPS estimates falling to -10% by the end of April. Full year 2020 EPS growth will not be positive. There is a 0% chance of that.
Wacky Goldman Forecast
Everyone is talking about Goldman’s equity forecast. It is the craziest forecast I’ve ever seen from a major investment bank. That doesn’t mean it won’t come true though. As you can see from the chart below, the firm sees the S&P 500 falling to 2,000 in the next 3 months, but rising to 3,200 by the end of the year.
That’s because it sees the worry about COVID-19 wearing off. Personally, I think the firm is too bullish. But I do think stocks are a buy right now if you plan to hold them for at least 2 years. Near term volatility is a given.
Only period where volatility was greater than today was in 1987. Reconstructed VXO data shows the VIX would have been at 150 in 1987. This type of trading action that occurred in 1987 and is occurring now happens once in a generation. We likely won’t see such volatility in the next 20 years. The chart below shows the 10 day S&P 500 realized volatility index.
As you can see, it is higher than it was in the 2008 financial crisis. This situation is only analogous to 1929 and 1987. It might be similar to the panics of the early 1900s, but I haven’t seen data from then. This market is like if 9-11 and 1987 were combined. You have people dying from a virus combined with a record setting sharp decline in stocks.
The stock market has fully priced in a recession. Unless you think a depression is coming, you should buy stocks. There is little downside from here. Even if you see a depression coming, it probably makes sense to buy stocks for the long term. However, we might only be halfway done with the decline if a depression hits.
A depression would occur if the economy doesn’t reopen until a COVID-19 vaccine is discovered and can be used. Earnings estimates haven’t fallen nearly enough. Usually, that’s a bad thing, but with stocks down 30%, it’s not. It’s the most volatile period in a generation. This type of event occurs about 3 times per 100 years.
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