In our , we looked at a bifurcated economy asked “What may tip the scale?” We got our answer in the first quarter: the novel coronavirus.
As COVID-19 spread around the world in the early months of 2020, governments enacted quarantines, travel bans, school closings and other measures. Global supply chains were disrupted. Reduced demand is weighing on many industries, starting with travel, hospitality and leisure. Oil prices dropped after Saudi Arabia boosted production, in effect launching a price war with Russia. U.S. Treasury yields fell to record lows.
Amid the uncertainty, analysts have cut earnings estimates—especially for the first quarter—while many companies have withdrawn earnings guidance altogether. With the “E” (earnings) and the “P” (price) in the price-to-earnings (P/E) ratio both dropping, assessing stocks’ valuations on forward-looking earnings has become nearly impossible.
Estimated earnings growth has been cut
Source: Charles Schwab, I/B/E/S data from Refinitiv, as of 03/16/2020.
So what do we expect going forward? It’s especially difficult to make forecasts during a global shock like the coronavirus, but here’s what we know now:
Global recession risk has risen
Although it’s likely we are entering a global recession, it’s too early to predict the magnitude. In response to the threat posed by COVID-19, the Organization for Economic Cooperation and Development (OECD) lowered its global gross domestic product (GDP) growth forecast recently by a half percentage point, to 2.4% for 2020. Generally speaking, global growth below 2.5% is recessionary.
However, global growth may bounce back quickly after the coronavirus recedes. Economic data was encouraging prior to the outbreak, with signs of a recovery in global manufacturing activity and continued strong U.S. jobs data—both of which are at risk again. Any rebound could be helped by a flood of fiscal and monetary stimulus—central banks in the U.S., China, Australia, and Mexico have already cut interest rates, while government fiscal stimulus has been added in Italy, Japan, South Korea, and the United States. More is likely on the way.
U.S. Treasury yields could stay low for a long time
We expect central banks and governments to continue efforts to cushion the potential economic blow. The Federal Reserve already has cut the federal funds rate—its benchmark short-term rate—to a range of 0% to 0.25% in an effort to support the economy through the crisis.
Fed officials announced on March 15 that they expected “to maintain this target range until [they are] confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” This could take quite a while, considering inflation has been below the Fed’s target for a few years and the unemployment rate is likely to rise. We expect the federal funds rate to remain near zero for an extended period of time.
Containment will be key
In past epidemics, such as SARS in 2003, stocks didn’t bottom until global new-case growth stabilized. While new coronavirus cases have continued to rise outside China, new-case growth seems to have peaked in mainland China. Aggressive measures taken in countries such as China and South Korea show that containment is possible.
Historically, stock indexes have tended to return to their previous trajectory within a few months of the peak in global new-case growth.1
What investors can consider now
There is no one-size-fits-all answer for how to respond to an event such as coronavirus. The best approach is to . However, here are a few steps to consider:
- Appropriate portfolio diversification among is very important. This includes domestic and global stocks, large-cap and small-cap stocks, and various fixed income investments, among others. These assets generally don’t all move in the same direction at the same time, so when one investment is performing poorly, another may perform more strongly. Diversification can help buffer your portfolio from the ups and downs of market volatility.
- We strongly recommend periodically rebalancing your portfolio back to its long-term asset allocation targets. Rebalancing means buying and/or selling assets to return your portfolio weightings back to their original desired levels—for example, 60% stocks/40% bonds, or another target allocation that is appropriate for your goals and investing time frame. Schwab clients can log in and use the tool to find out whether their asset allocation still matches the original target. If you’re not sure how to rebalance your portfolio, a financial advisor or a can help.
- U.S. large-capitalization stocks continue to be preferred over small-cap stocks. Overall, large caps have lower debt levels, better profitability; while they’re also more nimble with regard to tariff- and virus-related adjustments to their supply chains.
- Within your fixed income portfolio, we strongly suggest moving up in credit quality and exercising caution around riskier securities, such as high-yield bonds, because if economic growth slows it may become harder for less-creditworthy borrowers to make interest payments. Also, consider cash investments, such as money market funds, or short-term Treasuries or certificates of deposit (CDs). These have relatively low interest-rate sensitivity and historically have been relatively stable during periods of market upheaval.
- Don’t overlook the importance of diversification within the international portion of your portfolio. Headlines make for poor investment advice, and foreign stocks may outperform domestic stocks even during periods of global uncertainty.
¹ Source: Charles Schwab, FactSet, based on returns of the MSCI World Index from 01/01/1970 through 2/28/2020, including the following global outbreaks: HIV/AIDS (1981), pneumonic plague (1994), SARS (2003), H5N1 avian flu (2006), dengue fever (2006), H1N1 swine flu (2009), cholera (2010), MERS (2013), Ebola (2014, 2018), measles (2014, 2019) and Zika (2016). Past performance is no guarantee of future results.
What You Can Do Next
- Learn more. Keep up with Schwab’s latest market insights in .
- Make a plan. Having a financial plan and sticking to it can help you weather market ups and downs. If you need help creating a plan, Schwab is happy to talk wherever and whenever it’s convenient for you. Call us at 800-355-2162, visit a branch or find a consultant.
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