This is a guest contribution from Tom Hutchinson, Chief Analyst at Cabot Dividend Investor
This crazy pandemic market and economy is unprecedented. While the stock market has had a huge recovery from the lows, there is a good chance of another downward move. In the calm of a month-long rally, it’s a great time to target great stocks at bargain prices.
While the economy and market will ultimately recover from this crisis, there could be more trouble ahead. You might get another bite at the apple to buy great stocks at bargain prices ahead of the eventual recovery.
Expect Another Downturn
The market has grappled with pandemics in the past but never to anywhere near this degree in the modern era. There have certainly been economic downturns before. In fact, there have been 11 prior recessions in the post-World War II era. But we have never seen such a sudden and comprehensive economic crash like this.
Several reputable firms and analysts are calling for a 30% or 40% economic contraction in the second quarter. Let’s compare that to the contraction during the financial crisis, the worst recession since the Great Depression. In the worst quarter, the fourth quarter of 2008, GDP contracted 8.4%.
Of course, this recession is self-imposed to avoid the spread of the virus. The economy didn’t roll over on its own. Government restrictions crashed the economy. The easing of those draconian measures can revive it.
It’s like an athlete that’s injured. Sure, his combine numbers will fall off a cliff while his leg is hurt, but he will be right back in business when the injury heals. It will just take some time.
The market is sensing that the economy will restart sooner rather than later. As a result, the S&P 500 has rallied more than 25% from the lows in March. The index has recouped about 50% of the losses at the low and is now just 16% off the February 19 high.
I’m a believer in this country and this economy. We will overcome this virus and this recession. The economy will come back strong and so will the market. That said, there is a strong chance that the market has gotten ahead of itself in the near-term.
If all goes well and the virus continues to recede and the economy begins to restart in late May and June, it will still take time to overcome the damage already done. Many businesses will not survive the shutdown, and many more will find themselves in more debt and financially damaged in the aftermath.
Think about the consumer, which accounts for ~70% of GDP. The pandemic has put 36 million people out of work so far. The unemployment rate is at 14.7%, a number not seen since the Great Depression. In order for the economy to recover to near pre-pandemic levels those people will have to trickle back to work, recover the financial damage and regain confidence. That will take some time.
In the meantime, the S&P 500 is currently trading at roughly the same level as this past August, despite the significantly deteriorated fundamental backdrop. Of course, the market is forward looking and it focuses on improved conditions six to nine months from now. But it’s unlikely that the economy will be in August 2019 shape by then, even if the recovery goes very well.
Why has the market come back so strong and so fast?
One reason is that the disaster scenario in which the economy continues to be locked down into the summer and beyond, doing long-term damage to the economy, seems to be unlikely. Fear of that situation drove the market to the lows in late March.
It’s also true that with record-low interest rates money has no place else to go but stocks to earn a decent return. As fear subsides, there’s a lot of money on the sidelines attracted to some of the cheapest stock prices in many years. Investors realize that this economic crash is a temporary situation. And this may be a rare opportunity.
But there are good reasons to believe there could be more trouble for the market ahead. The market is factoring in a “good scenario” that may not happen. The virus could come back as the economy opens up, prompting a retreat. The global economy probably won’t recover as well as America’s, thus dragging our economy down.
The economic damage already done hasn’t been fully realized. Earnings and economic numbers will be horrible. The market won’t like that. There will at least be speculation of long-term economic damage and pain. Gloom and doom prognosticators will come out of the woodwork and forecast the end of prosperity.
Prepare to Buy Great Stocks at Bargain Prices
The market is unpredictable in the short-term. It has a habit of confounding sound reasoning. It could just run away and never look back. That’s certainly possible. But there is a strong enough chance of another downturn that it is worth preparing for.
Instead of fearing another selloff, get ready to exploit it. The market may give you another golden opportunity to pick up great stocks at bargain prices. Good companies purchased at great prices in a selloff can turn out to be the best investments of a lifetime.
It’s worth targeting companies you would love to own at significantly below current market prices. In the latest issue of my Cabot Dividend Investor advisory, I targeted two fantastic companies that are almost never cheap at below market prices. To learn their names, simply click here.