Additional Fed Easing Looks Likely
Federal Reserve policy represents one reason for hope. While monetary policy itself cannot prevent the likely economic damage, the Fed has made it clear it will respond as economic activity weakens. Markets are currently forecasting three rate cuts in 2020. Absent the spread of the virus, the Fed would likely have remained on hold before the U.S. election, but now rate cuts seem likely. Fed rate cuts are likely to boost investor sentiment and risk assets, which has been the case since the current economic recovery and expansion began over 10 years ago.

The Political Environment Has Also Become Less Clear
The growing coronavirus threat has also changed the U.S. political landscape and increased uncertainty. President Trump had previously been benefitting from a strong U.S. economy and disarray in the Democratic primary process. Today, his election prospects face the risks of an actual economic decline and the fact that voters typically blame incumbents when things go wrong. A less-clear political backdrop is likely to contribute to market uncertainty and volatility.

U.S. Stocks May Be Approaching A ‘Tradeable Low’
Market panics play out differently. Sometimes, we see a giant meltdown followed by a quick recovery, such as at the end of 2018 and early 2019. Other times, markets experience long waves of selloffs before stabilizing, such as during the financial crisis. At this point, it’s too early to tell how the current panic will play out. The impact on economic growth and corporate earnings is still unknown. Some strategists have been forecasting flat earnings for 2020, but that seems mostly like a best guess.

Based on our assessment of the underlying economy and current valuations, our best guess is that we will look back at the current period of selling as an overreaction. We believe the current selloff should be viewed as a surprisingly fast and sharp correction driven by previously overvalued and overbought conditions and a potential drop in corporate earnings expectations, rather than a shift in underlying economic fundamentals. The relationship between equity prices and credit spreads is an important data point to consider. Typically, long-term collapses in stock prices happen in unison with major widening in credit spreads. That hasn’t been the case over the last couple of weeks, as spreads (outside of high yield energy) have widened only modestly.

This does not mean we expect markets to necessarily rise from here. A rally will ensue at some point, but new highs could be a long time away. Investors should be patient, prudent and should not try to time an actual market bottom.

We could remain in a choppy and frustrating market environment for some time to come. For now, we think it makes sense to focus on companies selling at reasonable prices and that have free cash flow they can put to work. When we do see an eventual rebound, we think cyclical sectors and value styles could be poised for a bounce, but the timing remains elusive.

Robert (Bob) C. Doll is senior portfolio manager and chief equity strategist.

1 Source: Bloomberg, Morningstar and FactSet

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