How to Avoid a Financial Train Wreck
For today’s investment insights, we turn to Thomas the Tank Engine.
If you have kids, you know that Thomas is the hero of a series of animated morality tales about anthropomorphic locomotives. Last Father’s Day with my toddler grandsons, I watched a video whereby Thomas warned another locomotive named Spencer that he was going too fast. Heedless and arrogant, Spencer eventually derailed.
I couldn’t help but think of the stock market. The rally since late March has been a runaway train, destined to jump the tracks. Investor hubris won’t go unpunished.
Perhaps foreshadowing the wreck to come, the three main U.S. stock market indices on Wednesday closed deeply in the red. The Dow Jones Industrial Average fell 2.72% (710.16 points), the S&P 500 fell 2.59%, and the tech-heavy NASDAQ composite fell 2.19%.
In pre-market futures trading Thursday morning, the three indices were poised to extend their losses. The main culprit for the market’s swoon: rising cases of coronavirus.
I’m not counseling you to dump stocks altogether. That’s never a good idea. But you need to put defensive measures in place.
Despite the happy talk of those who wish to downplay the crisis, the coronavirus pandemic is actually getting worse in some countries and the U.S. On Tuesday, six states reported a record number of new coronavirus cases. They were Arizona, Florida, Nevada, Oklahoma, Oregon, and Texas. The verdict of health experts is that these states re-opened too soon.
The dynamic is simple: when the number of coronavirus cases goes up, economic prospects go down.
Economic recovery is likely to be impeded by a spike in infections and hospitalizations, a wave of bankruptcies as unemployment benefits expire, and consumers’ reluctance to return to gyms, hair salons, restaurants, and other parts of their routine. (Speaking for myself, I’m in no hurry to return to the gym or the local bar.) Compared to previous recessions, the recovery from this recession will be bumpier and longer.
Synchronized global contraction…
The International Monetary Fund (IMF) on Wednesday further lowered expectations for the global economy, projecting negative growth in 2020 for all regions of the world for the first time in the history of IMF forecasts. In the post-World War II era, we’ve never witnessed contraction in every region during the same period (aka synchronized).
The IMF’s update of its World Economic Outlook projected that the global economy would contract by 4.9% in 2020, a downward revision from its April forecast of a 3% contraction (see the following table for an excerpt).
The IMF report stated: “The COVID-19 pandemic has had a more negative impact on activity in the first half of 2020 than anticipated, and the recovery is projected to be more gradual than previously forecast.”
The IMF called the pandemic’s damage to the global labor market “catastrophic.” The silver lining is that growth is expected to resume in 2021, as the above table shows.
And yet, Wall Street has been largely ignoring the economic calamity. In fact, U.S. stock indices are set to post their best quarter in nearly 50 years. The S&P 500 is up about 21% so far in the second quarter and is on pace for its biggest quarterly gain since the first quarter of 1975.
The NASDAQ has been on a tear, up about 31% since the end of the first quarter and on the verge of its second-best quarter in history.
It’s easy to see why the NASDAQ is outperforming. Factors are currently in place, mostly fueled by the pandemic itself, that are positioning technology companies for a massive resurgence once this virus is under control.
But large-cap tech stocks have gotten pricey and they’re vulnerable for a downfall when the sector’s next operating results come in. In the current economic environment, earnings report cards for the rest of this year are likely to be ugly. Many S&P 500 companies have either downgraded guidance or withdraw it altogether, amid growing uncertainties and unreliable metrics.
Investor optimism over economic re-openings is on a collision course with surging coronavirus cases. Talking heads on television who say the pandemic is behind us are living in an alternate universe. Lockdowns are getting reinstated, a medical necessity but a nightmare for financial markets.
Also threatening bullish sentiment are reports that the White House is weighing the imposition of billions of dollars’ worth of import duties on goods from Europe, in retaliation for the European Union (EU) threatening to block American visitors due to the pandemic’s rise here.
The EU’s threat of a travel ban is seen as a blow to U.S. prestige and a critique of our country’s handling of the crisis. In Europe, cases are generally falling. It’s also a reflection of lingering European resentment over the Trump administration’s travel ban against Europe in March. These tit-for-tat measures are yet another headwind for global growth.
Amid these mounting risks, how should you trade? If you haven’t already, make sure your portfolio contains exposure to safe haven stocks, especially utilities.
For the best utility stocks now, click here for our report. In this report, our analysts warn that the broader stock market could soon drop another 31%, but they pinpoint dividend payers in the utilities sector with a proven history of generating high income even during downturns. Consider investing in these “defensive” plays, to stay firmly on track.
John Persinos is the editorial director of Investing Daily. He writes Mind Over Markets, Monday-Friday. You can reach him at: email@example.com