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The Dow Just Suffered Its Worst Week Since 2008. Let the Recession Watch Begin.


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Photograph by Eduardo Munoz Alvarez/Getty Images
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The stock market fell too far this past week. The stock market didn’t fall enough.

Both of these statements might be true. The Dow Jones Industrial Average slumped 3,583.05 points, or 12%, to 25,409.36, while the S&P 500 index tumbled 11%, to 2954.22, and the Nasdaq Composite also slid 11%, to 8567.37. All three benchmarks suffered their worst weekly drops since October 2008. To put that in perspective: The S&P 500 shed more than four months’ of gains in just seven trading days.

That the market tumbled as much it did because of the coronavirus also feels almost too obvious too mention. Investors had been hoping that the disease would remain in China, but it managed to breach that nation’s defenses and spread to Italy and South Korea. With that, all bets were off, and each comment made by health officials seemed only to further panic investors. If the stock market had been priced for an earnings acceleration in 2020, by the end of the week it was priced for no growth.

After a tumble like that, a rally could be in the offing. After all, this isn’t the first time that an epidemic has rocked the stock market. The S&P 500 fell 15% after SARS hit the market in 2003, but was up just over 1% six months after the outbreak began. That’s probably the most applicable historical guide to what the market is experiencing now, says Jason Pride, chief investment officer of private wealth at Glenmede.

“SARS provides the best illustration of the market’s path,” he says. “You go through a period of realization that this is an epidemic. But it’s a temporary phenomenon.”

Others liken the coronavirus outbreak not to other epidemics but to events like 9/11. When the U.S. was attacked, the economy ground to a halt, writes Raymond James strategist Tavis McCourt. The Federal Reserve responded by lowering interest rates, which helped the stock market quickly reverse its losses. “Whether this ends up like a 9/11 selloff/recovery or is deeper or longer is really reliant on the facts on the ground in determining to what degree and for how long this will impact the economy, which is still an open question,” McCourt explains.

In the short term, we wouldn’t be surprised to see the market bounce. The major indexes are oversold—and then some. Even after the market bounced off its lows on Friday, the S&P 500’s relative strength index, a measure of momentum, dropped to 19.1, a level that usually sees stocks rebound quickly. Some 93% of S&P 500 stocks were trading below their 50-day moving averages on Thursday. When the latter has occurred, the S&P 500 has been higher three months later 78% of the time, according to Sundial Capital Research data.

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But there are other factors at work than the virus alone. As the stock market sank into a correction this past week, we couldn’t help but think back to March 2019, when the yield on the 10-year Treasury note fell below that of the three-month bill. Such a yield-curve inversion has been a fairly reliable sign that a recession is looming, but also an imperfect one because stocks rarely peak when the yield curve inverts.

The economy did, in fact, weaken over the course of 2019—the Institute for Supply Management’s manufacturing survey fell below 50, a sign that industrial activity was slumping—but then the Federal Reserve started cutting rates, the yield curve uninverted, and January’s ISM manufacturing survey came in at 50.9, a sign of a nascent economic recovery. As the stock market rallied though the end of 2019 and into 2020, it was easy to forget about the possibility of an economic slowdown.

The market rally, however, might have obscured other problems in the economy. The Job Openings and Labor Turnover Survey, known as Jolts, fell to near a two-year low in December, the most recent data, while retail sales were also sluggish.

“The risks are obviously rising,” says Michael Darda, market strategist at MKM Partners. He was worried about a recession even after the market rallied into the new year, and that the economy was just one shock away from a slowdown. “The coronavirus could be the straw that breaks the camel’s back,” he adds.

If that is the case, a rebound, when it comes, might best be used to rebalance one’s asset allocation and prepare for another downturn, rather than to stock up on supposed bargains.

Eventually, though, when we look back, the entire episode is likely to be a hiccup. In the Credit Suisse Global Investment Returns Yearbook 2020, Elroy Dimson of Cambridge University and Paul Marsh and Mike Staunton of the London Business School look back at 120 years of global stock returns, and note that equities have returned 5.2% annualized, but that investors could expect something closer to 3.5% given that short-term Treasury rates are so low. That’s not great, but it’s better than nothing.

“When we look at this in 20 years’ time, it will be just a blip,” Dimson says of the current selloff.

Even if it doesn’t feel like one now.

Write to Ben Levisohn at ben.levisohn@barrons.com


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