1. Stock Market Not Pricing In The Impact Of Coronavirus
Governments across the world often use the stock market as a signaling tool to calm the masses. If stocks are going up, people are likely to underestimate the severity of a crisis. Although equities have shrugged off coronavirus concerns, commodities have not. Brent crude oil has priced in the impact of the outbreak. The demand for oil has collapsed following the outbreak, and it’s only natural for the price to follow. This is how price discovery works absent central-bank intervention. China accounts for over 19% of the world’s GDP and is deeply integrated into the global supply chain. Nearly a third of the Chinese population is reportedly under quarantine. Economic hubs like Shenzhen, Beijing and Shanghai, which account for a substantial portion of Chinese GDP, are all under lockdown. So it’s highly unlikely for a shutdown in China to not have an impact on global stocks.
2. Dwindling Buybacks Threaten The Stock Market
Corporate buybacks have been the primary driver of the U.S. stock market. Since the Great Recession, U.S. corporations have been the biggest buyers of their stock. Thanks to the low-interest rate policy of the Federal Reserve and tax cuts by the Trump administration, corporations have taken on debt in record numbers. They have used this debt to buy back their shares. This excessive demand has pushed stocks to record highs. On a rolling three-month basis, stock buybacks are tumbling at a rapid pace. Perhaps management at these companies thinks buying back stock at record highs is not the best use of their money. Without these buybacks, there will be nothing supporting the stock market.
3. Falling Earnings Make Fundamentals Worse
Buybacks not only create excessive demand for the stock but also hide falling earnings. When companies buy back their shares, the number of shares outstanding decreases. This, in turn, pushes the earnings per share higher, and masks the overall decline in profits. Corporate earnings have been falling for several quarters now as per Fact Set: For Q4 2019, the blended earnings decline for the S&P 500 is -2.1%. If -2.1% is the actual decline for the quarter, it will mark the first time the index has reported four straight quarters of year-over-year earnings declines since Q3 2015 through Q2 2016.
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