Charting the Market: After a Fast and Furious Correction, What Lies Ahead?

After the S&P 500® Index posted its fastest correction in history, many investors are wondering about the ramifications for the global economy and its growth potential in 2020. In a key development, the Federal Reserve (Fed) executed an emergency rate cut of 50 basis points on March 3^rd to ease the possible economic disruptions caused by the spread of the new coronavirus, yet the market’s reaction was mixed.¹

On one hand, a rate cut will likely lower the cost of capital and free up more money to potentially offset the business impact from a shift in consumer behavior. On the other hand, it won’t limit the spread of the virus nor remedy manufacturing losses throughout the supply chain. A rate cut isn’t a cure for the virus; even with monetary policy actions, the outlook for growth is cloudy.

Here, we examine the latest trends in economic and fundamental growth prospects for 2020 and their portfolio implications.

Sentiment and manufacturing measures take a leg down
As shown below, economic sentiment recently turned positive after weathering several challenges in 2019, including trade wars and Brexit delays. With the spread of the new coronavirus, however, sentiment is likely headed back to an underwhelming state.

In fact, we have already seen manufacturing figures from all corners of the world disappoint in early March. Output contracted in 15 of 31 economies,² including China, Japan, Germany, France, Italy, Taiwan, South Korea and Australia. The US and UK saw output growth, albeit below estimates. The coronavirus impact was evident in China’s February data, as shown below.

As a result, we have seen a coordinated response from monetary policymakers and G7 nations. On the fiscal side, though, no specific plans have been offered yet—just forward guidance. China and Malaysia have enacted some relief, but it is localized to each nation.³

Key takeaway: Don’t expect economic growth to act as a tailwind or a volatility backstop in 2020. Do expect more downside revisions to figures worldwide, with some nations (i.e., China) likely falling well below their trend rate.

2020 earnings growth estimates fall to zero
As the new coronavirus continues to spread, analysts at both JPMorgan and Goldman Sachs have indicated that 2020 earnings growth could be zero for S&P 500 firms.⁴ They aren’t alone in downgrading estimates, as shown below, nor are the downgrades confined to the US. Over the last year, there have been more downgrades than upgrades for every major region, with the ratio falling in February—right as coronavirus news broke worldwide.

Growth revisions were already skewed to the downside, as illustrated by the three-month changes to 2020 EPS estimates shown below. Only Emerging Markets managed to post positive changes in recent months, though that has since changed.

Key takeaway: Sentiment around global earnings was already negative and is likely to be exacerbated by fears stemming from the coronavirus’s impact on supply chains and consumer behavior. Don’t expect fundamental growth to act as a tailwind or volatility backstop—remember, we had three Fed rate cuts in 2019 and growth was already subdued.

Q1 2020 earnings to be an important gauge
Offering the first results since the coronavirus outbreak, the Q1 2020 earnings season will be an important fundamental event to gauge sentiment. Negativity around earnings is reaching across sectors in the US. Cyclical sectors potentially impacted by a reduction in global demand, such as Energy, Industrials, Materials, and Consumer Discretionary, have seen the most negative earnings growth changes—not only for Q1 but also for the entire year.

Only the Tech sector has seen meaningfully positive changes to its 2020 earnings estimates, despite having sizeable revenue exposure to China and other overseas nations.⁵ The positive changes stem from an improved outlook for expanding technologies, such as cloud computing and other software services. A strong Q4 2019 earnings season is also helping, given that Tech had:⁶

• A strong majority of companies surprise on earnings (85%)
• The second-largest magnitude of earnings surprises (+8.6%)
• The second-largest percentage of companies surprising on revenues (81%) 
• The second-largest magnitude of revenue surprises (+2.4%)⁷

Currently, six sectors are projected to have positive earnings growth in Q1.⁸ With the severity of the coronavirus impact still very much unknown—especially at the tail end of the month when these revisions were being made—we can expect growth across the sectors to be taken down a notch, led by cyclicals. As such, the number of sectors posting negative earnings growth may increase. Given that Microsoft and Apple have already forewarned issues,⁹ expect figures for the tech sector to also decline but remain in positive territory.

Key takeaway: Don’t expect strong earnings growth to drive markets. The Fed rate cut may offset some weakness, but revision trends were negative in 2019 despite three rate cuts, as noted above. For 2020, a continually lower bar means firms will need to significantly jump over it in order to attraction positive attention. Stocks that disappoint could be uniquely punished.

Growth stocks may become even more attractive
A low-and-slow growth environment hasn’t been a major problem for stocks. Earnings growth in 2019 for S&P 500 firms is estimated to be 0.6%, after all firms finish reporting.¹⁰ Three of the four quarters in 2019 had negative earnings growth, yet the S&P 500 returned more than 30% for the year. Trends in global earnings and equity performance were similar even though the IMF downgraded global growth to 3.1%, the lowest rate since 2009.

All this low growth has led investors to pay up for growth stocks. Growth stocks have outperformed the broader market and value exposures by 10% and 20%, respectively, since 2018.¹¹ With rates going lower, higher-growth stocks become even more attractive as:

• Low rates indicate lower growth prospects, so if growth is scarce, then the ones who are growing may benefit
• Their cash flows are now being discounted at a lower rate, increasing the growth premium and the attractiveness of those cash flows
• The cost of capital is now low and financing of high risk/high reward projects is easier to undertake.

Valuations, a shown below, haven’t stopped investors from gravitating towards growth stocks and the premium on growth stocks is likely to increase. Current valuations for growth using a combined metric score plot in the top 97th percentile over the past 15 years. If this was extended back to the dot-com bubble, valuations would still be in the highest 90th percentile.

Key takeaway: Growth will likely continue to outpace value. The price for growth will also continue to increase, which may lead to a more volatile return path with idiosyncratic drawdowns, something we saw glimmers of late in 2019.¹²

If you feel heat around the corner
Markets are currently characterized by microbursts of idiosyncratic volatility and questions around growth stability—but valuations are elevated for the highest-growth firms. This was the environment before the coronavirus, too.

When some investors feel heat around the corner, they leave. With monetary policy acting as a potential support system, however, the ideal strategy may seek to mitigate market downside but participate in upside moves by targeting firms with quality growth characteristics trading a reasonable prices, such as the SPDR® MSCI USA StrategicFactors^SM ETF (QUS).

Continue following SPDR® Blog to keep up with my Charting the Market series and other market insights. You can also download our full monthly Chart Pack.