Think carefully before buying the dip

Time to buy the dip? That was a winning strategy in each of the past three big stock market corrections. Global equities were 19% below their February high as of Monday’s close. Pretty much a bear market and a decline on a par with sell-offs in 2011, 2015 and 2018.

But ponder what will happen to earnings before filling your boots. US stocks are cheaper. However, at almost 16 times expected earnings, they are still no bargain. The previous sell-off in 2018 knocked valuations down to under 14 times. In that rout, estimates wobbled but actual earnings ended up growing. Whiffs of recession then turned out to be a pure aroma of red herring.

The coronavirus is moving faster than anticipated. Italy has gone from 100 cases to blanket travel restrictions in 10 days. That real-world impact makes comparisons with recent sell-offs imprecise. Bond markets are sending worrying signals. Yields on 10-year treasuries have collapsed to record lows of below 50 basis points.

An oil market bust all but eliminates the prospect of inflation and adds further downward pressure on corporate earnings. A comparison with 2015 is useful. Global earnings declined 15% when growth in Asia stalled and oil prices collapsed. Declines were focused on raw material and energy stocks. Those sectors now account for a smaller proportion of benchmarks and a similar shock this time would knock earnings 8%, says Robert Buckland at Citi. That estimate assumes growth in global output of 2.5% this year. Added to that will be the full impact of the coronavirus, which we can only guess at. If the actions of China, South Korea and Italy become the status quo, a global recession seems likely.

Even a small slowdown in global growth to 1.5% could mean earnings falling 20% this year. Adjust US valuations by that amount, and stocks are trading at closer to 20 times forward earnings estimates.