EC The Market's Worst Days Are Behind Us

The chart below shows the year-to-date performance of the S&P 500, Nasdaq Composite and the Russell 2000 indexes.

(Click on image to enlarge)

Please note that the Russell 2000’s underperformance is primarily a function of the small-cap index’s greater weightage for the Energy and Finance sectors relative to the S&P 500 index. While stocks in some of the more defensive sectors have fared a little better than the broader indexes, it has overall been a tough patch for stock market investors.

With the S&P 500 index historically losing about a third of its value in response to recessions, it is reasonable to expect that the bulk of the pullback is behind us at this stage. The chart below shows the 15-year valuation history for the S&P 500 index, on a forward 12-month P/E basis.

(Click on image to enlarge)

Over this 15-year period, the index has traded as high as 19.3X (November 2017), as low as 10.6X (September 2011), and a 15-year median of 15X. In other words, we are trading below the 15-year median. The downturn has squeezed the market multiple by roughly -26% at this stage.

We got into this downturn not because of a structural problem in the U.S. economy, but rather because of an exogenous shock (the virus outbreak). I strongly believe that the market will find its collective footing only after it gains greater confidence and visibility on the underlying driver, meaning the outbreak.

And since there are no easy or quick fixes on the virus front, at least through the next four to six weeks, it is reasonable to expect the market to sputter around current levels, with a bias to the downside as the outbreak moves towards its peak and we digest ominous headlines about the outbreak’s human and economic toll.

That said, the bulk of the sell-off is likely behind us and the best investment strategy for those with a longer holding horizon, beyond the next one to two years, is to start accumulating small positions in quality blue-chip names that are now available at 20% to 30% discounts relative to where they traded 5 or 6 weeks ago.

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