Argus Research on Navigating a 2020 Recession

04/14/2020 5:00 am EST


Stephen Biggar

Director, Product Strategy, Argus Research Corporation

Argus is now looking for a recession in 2020, cautions Stephen Biggar, director of financial institutions research at Argus Research. Here is an update on the independent Wall Street research firm's outlook for GDP, interest rates and markets in the wake of the coronavirus.

The depth and length of that recession is contingent on multiple factors, including the fiscal policy response from the government and the monetary response from the Fed; the success of stay-at-home initiatives; medical advances in treatments and vaccines; and potential seasonality of the virus.

For U.S. GDP, Argus looks for a slight decline in 1Q20 to give way to mid- to high-single-digit declines in the middle quarters of 2020, followed by fractional growth in the fourth quarter. We look for sharp rebounds in the middle of 2021. Altogether, we expect a low-single-digit decline in 2020 GDP and low- to mid-single-digit growth in 2021 GDP.

Prior to March 2020, a record number of U.S. citizens were employed. While that may not be the case now, in theory many of these citizens will have jobs again. That, of course, assumes the economy is revitalized.

Fears of the global pandemic prompted investors to pile into safe assets, led by U.S. Treasuries. Amid that crush, interest rates have bounced around while remaining near historical lows. More than the absolute level of interest rates, investors are focused on the Fed’s ability to maintain liquidity in the markets while lessening the burden of interest owed on short-term assets.

The Fed has been able to provide monetary relief rapidly, slashing the fed funds rate to zero, providing open-ended quantitative easing, backstopping the Commercial Paper Funding Facility and strengthening the Primary Dealer Credit Facility.

This is in contrast to 2008, when liquidity evaporated and the credit window closed. We have reduced our S&P 500 2020 EPS estimate from continuing operations to $146 from $180. We had formerly been assuming 10% growth from the approximately $161 in continuing operations earnings for 2019.

We now look for a 10% decline — and we stress that our estimates are highly preliminary. Within our model, we are assuming a minor tail-off in 1Q earnings. We look for second-quarter earnings to fall sharply, followed by additional (though less severe) weakness in 3Q20.

Earnings for the fourth quarter should reflect the “new normal,” which has yet to formulate. On a sector basis, we are modeling 30%-plus declines in Financial Services, Energy, and Consumer Discretionary, with the Industrial sector also weighed down by aerospace and transport.

The relatively better sectors are likely to be Utilities and Staples, as consumers keep the lights on and become homebodies.

For 2021, we look for 11% rebound to $162 per share in continuing operations EPS. Our estimate assumes substantial government support for hurt sectors, including Energy, Discretionary, Materials, and parts of Industrial.

There is a potential for a stronger rebound; continuing operations EPS in 2010 jumped by 48%. There is equally the possibility that 2021 EPS could fall further if stimulus proves insufficient and/or the pandemic sticks around. For 2020 to date, every equity sector has seen steep losses.

Yet the themes of recent years still hold. Growth is outperforming value. Nasdaq is relatively outperforming blue chip. And the small-cap Russell 2000 is deeply lagging.

So far in 2020, the market is trading neither on fundamentals (monetary and fiscal stimulus) nor on technicals, but on the pace of the pandemic. In what has become a global war, mankind needs to win a battle, and a slowing in case growth in New York State would represent just such a victory.

Incremental wins might help the stock market find a floor. In 2002-2003 and in 2008-2009, the market put in double bottoms approximately three to five months apart, thereby establishing a base from which to rise again.

One silver lining from the selloff is a better valuation outlook. Our normalized estimate, which looks back three years and forward two years, has dipped to the $150s from low $160s.

Using our adjusted earnings-yield model and taking into account low levels of inflation and interest rates, as well as lower EPS inputs, the S&P 500 is 5%-10% below fair value. Our revised year-end S&P 500 target is 2,800, within a range of 2,000 to 3,500.

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