Market Insider

The market sell-off could reach 10%, but most analysts expect much less because of Fed backstop

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Key Points
  • Some strategists say the stock market could sell off between 5% and 10%, in a pull back sparked by the outbreak of a new coronavirus in China.
  • But the decline has morphed to include concerns that a progressive Democratic presidential candidate could win the nomination, as Bernie Sanders makes a stronger showing in polls.
  • The Fed meets Tuesday and Wednesday, and analysts point to the easy policy of the central bank and those of others around the world as a reason stocks may not fall that much.
Traders work on the floor of the New York Stock Exchange (NYSE) on January 21, 2020 in New York City.
Spencer Platt | Getty Images

The easy policies of the Federal Reserve and other central banks are already providing a backstop that could lessen the impact of the coronavirus on financial markets.

Some analysts say the sell-off, which started last week, could be 5% to 10%. But others don't even expect it to be that much for U.S. stocks, which had been setting record after record before investors got spooked by the virus the week of Jan. 20.

"I don't think it's going to be 5%, 10%. We don't have enough information. Is it containment or is it contagion?" said Joseph Quinlan, head of CIO market strategy for Merrill and Bank of America Private Bank. "Does China contain it? I think it will, or is it contagion, and it really hits the global economy and pulls it down? I think it's the former. They're going to act very aggressively to offset any hit to to growth they see in Q1. We're not changing anything or doing anything dramatic in the portfolio."

The S&P 500 was down 2.6% in the five sessions through Monday. The Dow was down 2.8%, with a 1.6% decline Monday to 28,535, its worst one-day loss since October. It is now negative year-to-date. Treasury yields, which move opposite price, have fallen sharply as investors sought safety. The 10-year was at 1.60% Monday.

Futures pointed to a rebound on Tuesday with an implied open for the Dow of more than 100 points higher.

"They're overdoing it on the expectation of weaker than expected growth. The world is reflating. We had 64 central banks cutting rates," said Quinlan.

Fed meeting beginning 

The Fed cut rates for the third and final time in October, before stepping to the sidelines. It is also purchasing Treasury bills to expand its balance sheet, a move strategists say has added to liquidity and potentially risk taking in both stocks and credit markets. The Fed meets Tuesday and Wednesday, and is unlikely to change either policy for now, though traders expect it to sound vigilant regarding the uncertainties facing the global economy.

Lori Calvasina, head of U.S. equity strategy at RBC, said she has been expecting a pullback, and besides the coronavirus, the market is beginning to get nervous about the U.S. presidential election. The Iowa caucuses are Feb. 3, and Vermont Sen. Bernie Sanders is polling well in Iowa.

"I've been sort of banging the drum calling for a pullback for a long time. My view has been valuations are stretched and ripe for a pullback," she said. "It's always a mystery with these things what are the catalysts going to be. I's interesting its a virus in China."

Investors seem to be slightly less certain than before that President Donald Trump will win re-election as impeachment proceedings progress, but they are most worried the Democratic candidate will be Sanders, who is viewed as negative for the stock market.

"They were thinking it would be Trump or you would get a market friendly Democrat on the nomination side," said Calvasina. "This is all in the context of historical positioning and extreme highs in valuation. To a certain extent, maybe the virus is just the straw that broke the camel's back. Or maybe the election is. I don't dispute the virus has most of the responsibility here, but I think there's a kernel in it that's election-related."

Calvasina said she expects the recent decline in health care stocks could be related to the rise of Sanders, who supports Medicare for all. The S&P health care sector was down 0.7% Monday. A new New York Times/Siena College poll showed Sanders commanding 25% of the vote in Iowa, up six points since October and ahead of other candidates.

Online betting market PredictIt shows Sanders' odds of winning the Democratic nomination at 39%, 3 points above Joe Biden.

Buying opportunity?

"I think the markets fear would be if either Bernie Sanders or Elizabeth Warren wins the nomination. Their policies are not pro-market," said Ed Keon, chief market strategist at QMA. "In a two person race, there's always a chance the underdog can win. If either looks like they're going to win the nomination, that could be a significant market event."

As for the virus impact on stocks, it could turn into a buying opportunity, he said. "But it's way too early to say until we get more information. Partially, it's just whenever you have a big move up almost anything can serve as a catalyst to cause a pullback," said Keon. "If it wasn't this, it would have been something else. It's not unhealthy for a bull market to take a pause from time to time."

BlackRock's Rick Rieder said the sharp slump in Treasury yields is the result of fears about the virus, but the election could also be a factor. As for stocks, he expects just a single digit pull back.

"I could see it down three to five percent in the next couple of weeks to month. I have a hard time envisioning more than that," said Rieder, BlackRock's global CIO of fixed income.

Wall Street has been comparing the current virus to the 2002/2003 outbreak of SARS, which hit stocks but only for a short time.

Analysts warn, however, there are other factors at work in the last 17 years. The Chinese economy is now attempting to recover, and it was faster growing in 2003. There is also much more mobility among Chinese citizens who travel more inside and outside the country and could more easily spread the virus.

The virus appears to have started in Wuhan. China has shut down transportation, and basically locked down more than 50 million people. Plus, it has extended the new year holiday.

A small number of cases have shown up in other countries, including the U.S., Japan, Thailand, Malaysia, Singapore, Canada, South Korea, Taiwan, Australia and Vietnam.

Analysts say also note if there's a sudden surge of cases that could also rattle investors, and if there start to be large numbers of cases found outside of China, that could also shake the market.

The SARS virus did hit China's economy but the hit was temporary and after several quarters, the overall impact was a half percentage point on GDP.

"Even there, if you look at SARS it was a one quarter event that caught back up to itself three quarters later. Given that we had this incipient recovery, it could tilt the balance some," said Jack Ablin, CIO at Cresset Wealth Management. "I think it's more a matter of timing. It's really more when than if. I think ultimately growth will not be lost. It will just be pushed out a quarter."

Ablin said the fact the stock market's current valuation is high is a factor impacting investor psychology. "Any kind of uncertainty, anything that forces investors to look at valuations, can get people concerned," he said. "I'm more inclined to buy for longer term investors. I'm more inclined to use this as an entry point for longer term investors. I would say it's probably 5 to 10%. I don't' see it really spilling over into economic growth. I think its more a correction variety than a cyclical pull back. "

Ablin said he was reassured when he listened to the Center for Disease Control briefing Monday. "It seems like it's not getting out of hand. It's not mutating. We'll probably have a fair amount of uncertainty and perhaps a 'sell first' environment for a week," said "I think it's probably a good excuse for anyone who is inclined to sell, to lighten up. But it doesn't look like, from what we know now, that this is going to cascade into anything big enough to impact the global economy."