- Deutsche Bank chief US equity strategist Binky Chadha says the coronavirus-linked volatility and slowdown will follow one of four historic patterns, and all of them portend further losses.
- Even before the outbreak, Chadha thought stocks were going to bring in limited returns this year, and their losses so far don’t reflect how bad things might get.
- But for now, Chadha thinks the economic fallout caused by the outbreak will start to fade quickly and stocks will begin to recover within a few months.
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Wall Street pros like to say that different moments in market history “rhyme” — that they look similar to some other moment in history.
Yes, even a viral outbreak. Binky Chadha, chief US equity and global strategist for Deutsche Bank, says he’s identified four potential rhymes for the coronavirus epidemic.
That’s not to say Chadha is comparing the COVID-19 epidemic to other illnesses. What he sees are patterns that the market’s response to the outbreak and its effects on the global economy as estimates about the damage continue to pile up.
Despite the wild swings in the market over the past few weeks, he says they’ve only eliminated some froth from the market, and the process of grappling with the economic outcome is only just beginning.
“From a fundamental perspective, the market has only moved from being significantly overvalued relative to the fundamentals prevailing before the spread of the virus outside China, to being modestly so,” he wrote in a note to clients. “Equities are yet to price in any drops in macro and earnings growth from the expected slowdown in activity.”
Just a few months ago, Chadha’s year-end target of 3,250 looked pessimistic. Today it seems kind of bullish, and he says he doesn’t think the virus will cause too much economic or market harm over the longer term.
“We do view the impacts on macro and earnings growth as being relatively short-lived and the market eventually looking through them and maintain our year-end target of 3250 for the S&P 500,” he wrote.
With that in mind, Chadha says the slump will fall into one of these patterns.
(1) Geopolitical shocks
The resemblance between the COVID-19 epidemic and geopolitical risks like war or high trade tensions is easy to see because there’s so much uncertainty inherent in both.
“Both entail potentially large but difficult to quantify risks,” he wrote.
While international issues of that type can be frightening, from a market point of view, they tend to be resolved pretty quickly. If the coronavirus sell-off followed that pattern, Chadha says it would fall about 16.5% from the market’s February 19 high. That implies a low of about 2,825 for the S&P 500.
The drop would take about three weeks to finish, and then a recovery would take another three weeks.
(2) Vol events
This dive came at a time of stability for stocks, calling to mind the sell-off in mid-2011 — it’s been even more severe than the market’s rapid plunge in early 2018, the most recent “vol event.”
Chadha says historic comparisons show that if the current drop followed this playbook, it would take the S&P 500 a total of six weeks to fall 15%, reaching a low of 2,875. It would then take about four months to recover its losses.
“A decline in volatility from extreme levels is an important precondition for investors to raise equity exposures, as it is a critical input into risk management models for both systematic strategies and discretionary investors,” he wrote.
While Chadha says the current decline is a type of vol event, the outcome is likely to be more painful.
(3) Growth slowdowns
Based on the way the outbreak is hitting the global economy, Chadha says this is the most likely outcome today. Growth scares typically involve a drop of about 20%, which would wipe out nearly all of the market’s 2019 gains. That would take the S&P 500 down to about 2,700, a level it last hit in January of that year.
That slump would play out over about three months and a recovery would take about four more months. He expects growth to skid over the first two quarters of the year and that the market will reach its low point late in the second quarter.
“We see markets likely continuing to respond to sharply slowing growth, but bottoming as signs of a turnaround emerge,” he wrote.
(4) Worst-case recession
What’s notable about this scenario is that Chadha believes the normal span of a recession would be dramatically compressed: In a typical recession, he says, the S&P 500 falls 30% from peak to trough over the course of 14 or 15 months. Here, Chadha believes the index would take about seven months to suffer a loss of that type.
“In the current context, with growth falling far more suddenly and rapidly than is usual, the timeline for the onset of recession and the market selloff is likely to be highly compressed,” he said.
That would knock the S&P 500 down to about 2,370, a level it last hit in April 2017. For now, he’s doubtful that things will get that bad — but if there’s anything the last couple of weeks have made clear, it’s that a lot can change in a short time.