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- As the coronavirus outbreak's economic impact starts to come into focus, Goldman Sachs and Morgan Stanley are telling investors what might happen if the epidemic causes a recession.
- David Kostin of Goldman Sachs says the S&P 500 could enter a bear market - its first in almost 12 years - and end the year at 2,450.
- Michael Wilson of Morgan Stanley says US economic growth in the first half of this year could be wiped out, with little improvement in the second half.
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It's rarely fun to think about a worst-case scenario, but it's part of figuring out what the future is going to look like.
The US stock chiefs at two of the biggest names on Wall Street - Morgan Stanley and Goldman Sachs - are now telling investors how badly they think coronavirus outbreak could damage the economy and the stock market.
As of Monday, the COVID-19 epidemic has infected more than 89,000 people in 70 countries and killed more than 3,000. While the vast majority of cases and deaths happened in China, there's growing evidence the illness is spreading around the world, and six deaths have now been reported in the US.
Last week was the worst for US stocks since October 2008, when the Global Financial Crisis was starting to hit with full force. And now the economic effects of the outbreak are starting to become clear. New data shows that growth in US manufacturing stopped in its tracks last month and factory activity in China nosedived.
That kind of slowdown makes a recession a possibility that has to be reckoned with. The two equity chiefs see it as a tail-risk scenario and aren't treating it as the most likely outcome, but both say the threat will have a major effect on the market.
Morgan Stanley: Near-zero US growth
Morgan Stanley's Michael Wilson says the US could report roughly zero GDP growth in the first half of the year, with minimal improvement in the second half. He says that would happen is there's another increase in coronavirus cases in China after it lifts its economic restrictions, and if the virus is still spreading in the third quarter of this year.
By that point, Wilson says, all of the world's major economies would be affected. He says that would also wipe out earnings growth and hammer stock prices.
"Flat GDP growth will remove any expectation of a return in operating leverage as revenue growth evaporates," he wrote. "We would expect multiple quarters of negative earnings growth."
One of the risks of this scenario, Wilson says, is that it will be hard to evaluate just how bad it's getting, and by this point investors will be ready to assume the worst. So even if the economy doesn't go into a recession according to technical criteria, the market will react as a recession one is occurring.
And that means some of the worst effects of a recession, including widespread company closures and job losses, would come to pass. Both of those would affect consumer spending, which has kept the US economy strong when it's been assailed on other fronts.
"Extended disruption brings the risk of damage to corporate profitability and a rise in corporate credit risks," he wrote.
Wilson says 2,750 is a "reasonable floor" for the S&P 500 if that happens. He also believes market leaders in the technology and consumer discretionary sectors could be in for more pain between now and then. Those stocks have sold off with the market, but that doesn't reflect the greater risks the outbreak poses to their supply chains and overall demand.
Goldman Sachs: A bear market
David Kostin of Goldman Sachs says that S&P 500 earnings would fall to $143 a share this year in a recession. With economic growth impaired, investors would continue to buy government bonds for safety and the Federal Reserve would begin cutting interest rates again.
Kostin says the yield on the 10-year Treasury note would sink to 0.75% and the gap between the dividend yield of the S&P 500 and the 10-year would widen to 575 basis points. That's compared to 450 basis points today - a number that is almost double the historic average of 230 basis points.
That would drop stock valuations, and Kostin says that would finally end the bull market that started in March 2009.
"The forward P/E multiple would decline to 15x and S&P 500 would end the year at 2,450 (-18% from the current level and down 28% from the peak)," he wrote.
Kostin concurs with Wilson that it's going to be hard to tell when the risks of COVID-19 are receding.
"No one rings a bell when a contagion ends, so a near-term reversal of behavior seems unlikely," he wrote. "Individuals and companies have adjusted their behavior in ways likely to reduce growth."
Get the latest Goldman Sachs stock price here.