The U.S. stock market has been crushed by the novel coronavirus pandemic over the past month. The Dow Jones Industrial Average has lost a quarter of its value in 2020, and the S&P 500 is not far behind with a 21% crash.
Despite all the doom and gloom related to the economic fallout of the COVID-19 outbreak, the U.S. stock market has bounced off its late-March lows.
But that recovery might not last for long. The upcoming earnings season could send the Dow and the S&P 500 to new lows.
Here’s why investors should brace for part two of the coronavirus-induced stock market crash.
History demonstrates that sustained declines in S&P 500 earnings batter the stock market .
This chart depicts three instances in the past decade alone when the S&P 500 tumbled following a period of earnings contraction.
Let’s use the Great Recession as a reference point. In 2008, S&P 500 earnings dove by 78% .
Economists warn that the COVID-19 pandemic could cause bigger economic damage than the downturn that accompanied the financial crisis. It remains to be seen how severely corporate earnings could crash this year, but almost every scenario appears grim.
UBS, which previously anticipated $170 per share in 2020 S&P 500 earnings, already slashed its full-year target to $140 in response to coronavirus.
Short-term forecasts are even more bearish . Analyst estimates compiled by FactSet expect a 10% decline in earnings during the second quarter following a 5.2% drop in Q1. That would be the first double-digit decline in a decade.
Given that the International Monetary Fund says that the world economy is already in a recession, don’t be surprised to see those earnings estimates whittled down further.
The Dow and S&P 500 have reclaimed some ground of late, but that could be nothing more than the lull before the storm. When earnings season begins in a couple of weeks, companies are likely to be clueless about what investors should expect in the coming quarters.
UBS points out that the disparity between Wall Street’s price targets and earnings estimates is at its widest in the past two decades. Equity strategist Francois Trahan wrote in a note (via CNBC ):
Such a large range of opinions on the part of analysts covering the exact same stocks highlights the absolute lack of visibility.
That doesn’t paint an attractive picture for the Dow and the broader stock market. The COVID-19 outbreak has sparked unprecedented economic volatility.
U.S. jobless claims shot up to an unheard-of 6.6 million last week, and unemployment could jump as high as 32%. Second-quarter U.S. GDP might contract as much as 50%, according to James Bullard of the St. Louis Fed.
All of this will weigh heavily on the earnings performance of corporate America as the spending power of consumers declines in the wake of the coronavirus pandemic.
The stock market won’t be immune, which is why investors should be prepared for another round of panic-selling in the Dow and the S&P 500.