A saying on Wall Street warns against trying to catch a falling knife. But in recent weeks investors have been confronted by a market that risks cutting their portfolio to ribbons.
Thursday brought more such slashing, with the Dow, or about 3.5%, and the S&P 500-stock index and Nasdaq composite dropping similarly. As investors assess the impact on their retirement funds and savings accounts, it's helpful to get a better idea of why stocks might be falling.
Here are three reasons why the coronavirus outbreak is driving one of the market's rockiest periods in years, and why, unfortunately, it may not be over anytime soon.
Falling earnings crunch stock prices
Stock prices are driven by corporate profits. So the expected global economic slowdown due to the fast spread of the coronavirus — and an attendant drop in earnings — is one of the biggest things throwing the market for a loop.
"The rapid global spread of coronavirus has triggered severe financial market turbulence and intensified recession fears," analysts with Oxford Economics said in a note to clients on Thursday. "Our recession indicators now point to higher odds of a recession this year."
Earlier this week, General Electric told analysts that the coronavirus could cost the global industrial giant $500 million in the first quarter alone. Microsoft has also said the coronavirus, which is fueling the outbreak of the deadly COVID-19 disease, will also hurt sales.
Goldman Sachs's top U.S. market strategist predicted late last month that a coronavirus-led slowdown would completely wipe out corporate earnings growth this year for the average company in the S&P 500.
Such forecasts could prove excessively dire, of course, and individual stock analysts are generally less pessimistic. FactSet says the average earnings estimate for companies in the S&P 500 has dropped 3.3% in the first quarter. That's pretty close to the average drop in any quarter in recent years — analysts are almost always too bullish early in the quarter before proceeding to revise their numbers downward.
Still, FactSet earnings specialist John Butters thinks more earnings downgrades are likely on the way. "Analysts may be waiting for more guidance from companies before revising estimates even lower for the first quarter," he said.
Wall Street remembers stocks are risky
Another reason the coronavirus is infecting financial markets has to do with how Wall Street evaluates stocks these days.
Risk has always played a factor. But ever since the financial crisis, there has been a growing number of mutual funds and stock traders for which risk is the main investment factor. The strategy, called "risk parity," sells investments where risk is seen as rising and buys where risk is seen as falling. The point is to always keep your overall portfolio risk at the same level.
The strategy has become particularly popular as more of Wall Street is driven by quantitative traders making lightning-quick trades through computers. About half of the money at Bridgewater, the world's largest hedge fund with $150 billion in assets, is managed like this.
Trouble is, there isn't a great way to calculate in advance how risky an investment will be. The common way Wall Street does it is based on the measure of how much stocks are rising or falling, namely volatility. And in times like the present, that can be a problem.
Markets have swung wildly because of the uncertainty around how a disease we know little about will impact the economy. "It is hard to get a clear estimate of what this will do," said Michael Crook, a strategist at UBS Global Wealth Management. "It's day-to-day and that is whipsawing the market."
The result is soaring volatility, fueled by a negative feedback loop. The Wall Street index that tracks volatility, nicknamed the VIX, or fear index, has soared to just over 40. It was at 13 less than a month ago. Bad news causes volatility, and volatility makes stocks look riskier — that drives more funds to sell, which increases volatility. At some point that pattern will be broken, but for now we are stuck in the middle.
Here comes deglobalization
The biggest unknown for stocks at the moment is how the coronavirus will change. And that change will likely happen whether the coronavirus results in a prolonged pandemic or resolves itself in a matter of months.
For years, the U.S.' largest companies have been able to lower costs and increase sales by expanding overseas. The coronavirus and the risks that come with it may cause companies to either dial back their overseas expansions or even put them in reverse. That will likely mean weaker profit growth, and likely slower increases in stock prices — at least for large multinational U.S. companies — than we have seen in the past.
"The business owners and corporate executives I have talked to say that is something they are thinking about," said UBS's Crook. "At the very least this is going to slow down the expansion of globalization."
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