Stocks rallied strongly after the March 2020 stock market crash. The leading Dow Jones Industrial Average gained an impressive 20% from the March market bottom and the S&P/TSX Composite rose by 21%. This notable performance sparked considerable optimism that the worst was over.
Nevertheless, a range of indicators point to a different outlook. There are growing fears that the market rally has outstripped fundamentals, creating conditions for another stock market crash.
Pandemic worse than expected
The coronavirus pandemic is far worse than anticipated. Back in January and February of 2020, it was being compared by many pundits to the 2002 SARS outbreak. That epidemic caused minimal economic disruption and was effectively contained.
The world’s largest economy, the U.S., has become a focal point for the pandemic. It has over a third of the reported cases globally, and there appears to be worse ahead. Cases are ratcheting upward, despite the implementation of stay-at-home orders and claims that the worst is over.
Measures taken to contain the pandemic, including stay-at-home orders, travel bans, and the shuttering of non-essential services, have caused grievous economic damage.
There are emerging fears of a second wave of the virus. China and Germany reported a spike in cases after loosening lockdown measures. The 1918 Spanish Flu pandemic had a second wave, which was considered deadlier than the first. If a second wave occurs, governments will scramble to contain the virus by reinstating containment measures further damaging already grievously weakened economies.
The outbreak of a second wave would spook an already fearful Wall Street, causing sentiment to sour, triggering another stock market crash, which would likely be worse than the first.
Economic stimulus is not enough
We are living in a unique moment in history. The extensive economic fallout from the coronavirus has seen developed nations around the globe implement economic stimulus measures, which rank, in many cases, as the biggest ever. The U.S. alone launched a package valued at a whopping US$3 trillion.
There is rising concern that this simply won’t be enough to spur growth. Federal Reserve Chairman Jerome Powell has voiced concern that existing stimulus will not trigger an economic recovery.
Normally, such extensive stimulus would act as a powerful economic growth lever, but with many economic sectors closed, activity is unlikely to be invigorated on the scale envisaged. For that reason, further stimulus and reactivation of the economy is required to trigger growth.
Deteriorating fundamentals
Economic fundamentals have deteriorated sharply since the start of 2020. The U.S. and Canada recently reported their worst recorded job data ever. Over 20 million U.S. jobs were lost in April, and the unemployment rate spiked to 14.7%. Canada lost almost two million jobs, and the unemployment rate soared to 13%. That provides an early indicator of the severity of the impact of the coronavirus pandemic on the economy.
There is worse ahead for both nations. According to the U.S. Bureau of Economic Analysis (BEA), first-quarter gross domestic product (GDP) shrunk by 4.8%, while Canada’s contracted by 2.6%.
The outlook for both economies is even worse, with GDP expected to contract further. Some analysts predict that the U.S. economy will shrink by a whopping 30% for the second quarter, while Canada’s could contract by up to 20%.
That will weigh heavily on unemployment, consumption, and business activity. It certainly doesn’t bode well for company earnings. Many Canadian companies have posted massive first-quarter losses. Suncor reported a $3.5 billion net loss and slashed its dividend by 55%. Husky announced a $1.7 billion loss and a 90% dividend cut, while Air Canada, one of the worst-affected companies, declared a $1 billion loss.
Such dire economic data and forecasts indicates that second-quarter earnings season will be worse in the U.S. and Canada, particularly because the full fallout from the pandemic has yet to be felt.
Sharply weaker company earnings could be the final catalyst required to spark another market crash.
Foolish takeaway
The expectation is a bear market worse than that which existed during the 2008 Great Depression. This makes it important to keep a cool head. As long-term investors, current events shouldn’t be viewed with fear but as an opportunity to gradually acquire quality stocks with solid fundamentals that will rebound when the crisis ends.
