Coronavirus: How Bad Can It Get?

The coronavirus outbreak prompted me last night to watch one of my favorite movies: “The Omega Man” (1971), a post-apocalyptic science fiction classic about a global pandemic that wipes out the human race. The last uninfected man, played by Charlton Heston, is stalked by an army of zombies. (Heston’s overacting in this movie is a guilty pleasure.)

The coronavirus currently spreading around the world is very real. And it’s no joke. As of this writing Tuesday, the death toll from the coronavirus outbreak has risen past 360 and the total number of confirmed cases has surpassed 20,000.

The epidemic control efforts underway in China include placing about 100 million citizens on lockdown, shutting down a national holiday, quickly constructing huge quarantine hospitals, and launching a crash program in the manufacture of masks and medical equipment.

That said, financial markets are bouncing back from their initial coronavirus-induced swoon. The three main U.S. stock market indices closed higher yesterday. In pre-market futures trading Tuesday morning, the indices were poised to open in the green. Battered Asian stocks have stabilized as well.

And yet, the coronavirus crisis isn’t over, not by a long shot. Another shoe might be waiting to drop. A resumption of unbridled bullishness is unwarranted.

Today, I want to conduct a level-headed risk assessment of the coronavirus. How real is the threat to your portfolio and how should you respond?

The truth about the coronavirus outbreak is elusive. Evidence is mounting that Beijing is engaged in a cover-up and the outbreak is far worse than the world realizes. A recent study published in the medical journal The Lancet estimated that the number of coronavirus infections could be about 76,000, far higher than the official number given by Chinese authorities.

Analysts already are downgrading their estimates for Chinese and global economic growth, due to the fast-spreading respiratory illness.

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The closest example to the coronavirus outbreak is the severe acute respiratory syndrome (SARS) outbreak in China in the early 2000s. SARS caused an eventual 8,098 cases, resulting in 774 deaths reported in 17 countries.

Over a six-month period between the reporting of the first SARS cases and the last reported case, the S&P 500 declined by 3.4% before bouncing back (see chart).

Back then with SARS, as now with coronavirus, airline and energy stocks slumped the worst. Chinese gross domestic product (GDP) also took a hit during the SARS outbreak, declining from 11% to 9.1% over the first half of 2003 before rebounding to 10% by year-end.

We can conclude that the SARS outbreak’s harm to stocks and economic growth was modest. However, it’s important to note that during the SARS outbreak, China’s exports were more oriented toward low-tech consumer items, such as t-shirts and plastic toys, whereas today China makes a greater number of sophisticated, valued-added manufactured goods. Accordingly, the coronavirus could exert a greater eventual toll than SARS on China’s GDP and global stock markets.

The Q4 numbers so far…

The good news is that health crises tend to be temporary. When they subside, attention returns to the hard data, such as corporate operating results. Let’s look at the numbers to date for Q4.

For fourth-quarter 2019, with 45% of S&P 500 companies reporting actual results, 69% have reported a positive earnings per share (EPS) surprise and 65% have reported a positive revenue surprise, according to research firm FactSet.

For Q4 2019, the blended earnings decline for the S&P 500 is -0.3%. (Blended combines actual with projected.) If -0.3% is the actual decline for the quarter, it will represent the first time the index has reported four straight quarters of year-over-year earnings declines since Q3 2015 through Q2 2016.

However, the blended year-over-year revenue growth rate for Q4 is 3.1%. The disconnect between earnings and revenue suggests that net profit margins are under pressure.

S&P 500 companies are reporting earnings that are 4.1% above expectations. This surprise percentage is below the one-year average of 4.5% and below the five-year average of 4.9%.

For Q1 2020, 24 S&P 500 companies have issued negative EPS guidance and 13 S&P 500 companies have issued positive EPS guidance.

The forward 12-month price-to-earnings (P/E) ratio for the S&P 500 is 19.2. This P/E ratio is above the five-year average (16.7) and above the 10-year average (15.0). That’s another disconnect: valuations are historically high, but earnings growth is negative.

The Utilities sector is reporting year-over-year earnings growth for Q4 of 18.8%, the highest of all 11 sectors. At the industry level, all five industries in this sector are reporting (or are expected to report) growth in earnings.

Four of these five Utilities industries are reporting blended double-digit earnings growth: Independent Power and Renewable Electricity Producers (139%), Multi-Utilities (26%), Gas Utilities (13%), and Electric Utilities (11%).

It’s a truism of investing: the dividend-paying stocks of companies that provide essential services are safe bets during troubled times. Now’s a good time to increase your exposure to safe havens such as utilities.

Boeing pushes Industrials into the red…

The Industrials sector’s fourth-quarter earnings growth is in negative territory, largely thanks to aerospace giant Boeing (NYSE: BA).

The Industrials sector is reporting the second largest year-over-year earnings decline of all 11 sectors at -10.6%. (The worst is Energy, at -42.5%.) At the industry level, six of the 12 industries in the Industrials sector are reporting a decline in earnings. Two of these six industries are reporting a double-digit decline in earnings: Aerospace/Defense (-37%) and Air Freight and Logistics (-14%).

At the company level, Boeing is the largest contributor to the year-over-year decline in earnings for the sector. The company reported actual EPS of -$2.33 for Q4, compared to year-ago EPS of $5.48. If Boeing were excluded, the blended growth rate for the entire sector would improve to +2.4% from -10.6%.

Read This Story: Why The Boeing Scandal Matters to All Investors

Scandal plagues Boeing’s best-selling product, the 737 MAX passenger airliner. The 737 MAX represents, by far, the single largest U.S. export product. Boeing is the world’s largest maker of planes for the military and commercial sectors and it’s America’s largest manufacturing exporter.

In March 2019, the U.S. Federal Aviation Administration and its counterparts around the world grounded the 737 MAX after two new airplanes crashed within five months, killing a combined total of 346 people. Boeing has halted production while it investigates the plane’s problems.

Apocalypse: Not Now…

It remains unclear how badly the coronavirus pandemic will hurt the S&P 500’s earnings and revenue in future quarters. But the immediate damage to certain sectors, such as aviation and energy, is apparent.

Boeing’s woes are compounded by the havoc wreaked by the coronavirus on the aviation industry, as flights are canceled and travel activity plunges. The coronavirus outbreak is generating travel bans and anti-Chinese xenophobia. China is the global economy’s growth engine. When China gets sick, the world sneezes.

The bear market in crude oil is deepening, as prices continue to drop and OPEC discusses emergency action to address the sell-off. Citigroup (NYSE: C) analysts this week estimated that oil demand could drop by 1 million barrels per day due to the virus.

However, modern history shows that illness outbreaks only exert short-term damage to markets. If the prognosis for the coronavirus outbreak improves, markets will respond favorably and this transitory health crisis will take a back seat to corporate and economic fundamentals.

The prudent stance is to stay cautious, resist emotionalism, and stick to your long-term goals. Unlike Charlton Heston in the aforementioned movie, we’re not facing the end of the world.

John Persinos is the editorial director of Investing Daily. You can reach him at: