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Get Ready: 10 Reasons a Second Stock Market Crash Is Coming

By Sean Williams – Jun 20, 2020 at 5:51AM

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Equities have had a ferocious rebound from the March 23 lows, but a bounty of negative catalysts remains.

There's little question that when 2020 comes to a close, investors will not soon forget it.

For a nearly five-week period, beginning Feb. 19, panic and a record amount of fear regarding the coronavirus disease 2019 (COVID-19) pandemic sent the broad-based S&P 500 (^GSPC -0.20%) to its quickest bear market descent in history. Before it was over, the benchmark index had shed 34% of its value.

Over the subsequent 11 weeks following the March 23 bottom, the S&P 500 bounced more than 40% off of its lows and got within sight of an all-time high. In fact, the technology-heavy Nasdaq Composite did hit a record high of more than 10,000. All of this was accomplished as the unemployment rate hit levels not seen since the Great Depression, nine decades earlier.

While there's no question that the stock market has a history of bottoming out well before the U.S. economy does, there's a veritable laundry list of reasons to believe that this rebound rally in equities has come way too far, way too fast. I present to you 10 reasons why a second stock market crash is coming.

A paper airplane made out of a 20-dollar bill that's crashed and crumpled on the financial section of the newspaper.

Image source: Getty Images.

1. Our COVID-19 knowledge is still evolving

Let's start with the basics: we still don't know everything there is to know about COVID-19. Seemingly every week there are conflicting reports about how easy or difficult it is to transmit the SARS-CoV-2 virus that causes COVID-19, and what tactics actually work (or don't work) in suppressing the disease. Even early-stage clinical trials have been conflicting, with early promise on hydroxychloroquine paving way to major disappointment once additional clinical studies were ramped up. There's a lot that we just don't know yet about COVID-19, and that makes predicting its near-term economic impact very difficult.

2. A second wave of infection appears likely

Another problem is that a second wave of infection appears likely. Although some countries have done a great job of weeding out the coronavirus, other previous hot spots have begun to see a re-emergence, such as Beijing, China.

Within the U.S., certain states that have predominantly reopened their economies, such as Arizona and Texas, have also witnessed a significant uptick in positive COVID-19 cases and hospitalizations recently. Though President Trump has vowed to not shut the U.S. down if a second round of COVID-19 infections occurs, it's all but a certainty that it would hurt business activity.

3. Business activity will be slow to bounce back

Speaking of business activity, the reopening of the U.S. economy is going smashingly well, according to President Trump. But in spite of a record 17.7% increase in May retail sales, many retail categories have dealt with a sales slump of between 20% and 60% over the past four months.  The simple fact that the U.S. still has 20.93 million continuing unemployment claims, as of May 30, speaks volumes. For context, there were only 1.7 million continuous claims in early March, suggesting that this economic recovery will be a slow slog. 

A businessman holding up a cardboard sign that reads, Looking for a job.

Image source: Getty Images.

4. Stimulus funding is nearing an end

Don't overlook the Coronavirus Aid, Relief, and Economic Security (CARES) Act as a source of future downside. While the $2.2 trillion CARES Act did provide money to distressed industries and small businesses, and is responsible for more than $267 billion in direct payouts to American workers and senior citizens, the $260 billion directed toward expanding the unemployment benefits program is slated to end on July 31, 2020.

For those unfamiliar, approved unemployed persons are netting $600 a week extra for the time being. This acts as a possible disincentive to return to work, and will most likely create a financial shock once this funding ends in six weeks.

5. Second- and third-quarter earnings will be awful

There's also no sugarcoating that second-quarter operating results are going to be abysmal. The Atlanta Federal Reserve is forecasting a decline in real gross domestic product for Q2 of around 45%, as of June 16. For certain industries, such as airlines, we're likely to see revenue down perhaps 90% from the prior-year period. In other words, it's going to be brutal and ugly -- yet the stock market is within reach of new all-time highs. 

Considering that the ramp-up of economic activity in the U.S. has been slow, and it may stay that way if a second round of COVID-19 infections hits, third-quarter operating results may feature a similar year-on-year decline.

6. Wall Street can't provide stepping stones for Q2 or Q3

A sixth -- and often overlooked -- reason a stock market crash is coming is Wall Street's inability to provide a stepping stone for publicly traded companies to leap over.

You see, far more often than not, publicly traded companies provide guidance that allows them to overshoot Wall Street's profit consensus. This leads to investors paying more attention to a company's relative performance to Wall Street's consensus rather than to how it did versus the prior year or sequential quarter.

For at least the second and third quarter, the vast majority of public companies have withdrawn their guidance due to COVID-19. This makes consensus sales and profit estimates difficult to come by, and will force investors to make (ugly) year-on-year sales and profit comparisons.

A hand reaching for a neat stack of cash in a mouse trap.

Image source: Getty Images.

7. Say goodbye to share buybacks and some dividends

Investors should also be concerned about the reduction in capital return plans associated with COVID-19. We've already seen most major airlines shelve their share buybacks and dividends, with major banks also halting their common stock repurchasing.

According to investment bank Goldman Sachs, stock repurchases in the S&P 500 are expected to decline by 50% in 2020 to $371 billion, which would be the lowest level for buybacks in 10 years. Without buybacks to prop up earnings per share, stock valuations could be tossed under the microscope in the months to come. 

8. Mortgage loan defaults are likely to rise...

Having nearly 21 million people out of work and collecting unemployment, as well as facing the end of the unemployment benefits expansion, it's only logical to expect rental and mortgage defaults to rise during the second half of 2020.

Based on recently released data from the Mortgage Bankers Association, the seasonally adjusted mortgage delinquency rate for all outstanding loans jumped 50 basis points to 2.67% in the first quarter of 2020. That ties the largest single-quarter jump dating back to when the culling of mortgage data began back in 1979. While this delinquency rate remains historically low, a survey from Apartment List found that 30% of Americans missed their housing payments in June. Translation: Delinquency rates are going to soar. 

9. ... As are auto loan delinquencies

The problem for the auto industry is that loan delinquencies were already rising well before the COVID-19 pandemic hit. As recently as the third quarter of 2019, 2.43% of borrowers with indirect auto loans were at least 30 days overdue on their payments, per American Banker, marking an eight-year high. But following Q1 2020, the median amount of delinquent loans tied to autos among large banks and lenders stood at 7.5%! 

Even though the auto loan market pales in size to mortgage loans, it's not something that can simply be swept under the rug. It will have negative financial implications on the financial sector.

A printing press producing one-hundred-dollar bills.

Image source: Getty Images.

10. The Federal Reserve has used up its "traditional firepower"

Finally, a second stock market crash is highly plausible because the Federal Reserve has used up its traditional monetary resources.

Historically, the average recession has been met with the Fed reducing the federal funds rate -- the overnight lending rate between depository institutions -- by 500 basis points. The problem is that the Fed only expanded the fed funds rate to a peak range of 2.25% to 2.5% during the longest economic expansion in U.S. history. Having reduced the fed funds rate back to an all-time low of 0% to 0.25%, the Fed has been left with no other choice but to lean on unconventional measures, such as quantitative easing (QE). To be frank, QE has a questionable track record over the long run.

Though it remains possible that the stock market could motor to a new all-time high, it seems far more likely that stock market crash round two is coming.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Nasdaq. The Motley Fool has a disclosure policy.

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