In many ways, this is a year that Wall Street and the American public will never forget. The coronavirus disease 2019 (COVID-19) pandemic has completely turned societal habits upside down, pushed more than 20 million Americans out of work, and sent the stock market into its wildest tailspin in history. It took just 33 calendar days for the broad-based S&P 500 (^GSPC -0.04%) to shed 34% of its value.
Then again, it's also a year that's witnessed one of the most ferocious rallies on record. Despite unemployment levels that haven't been seen since the Great Depression, the tech-heavy Nasdaq Composite has ascended to new highs, while the S&P 500 clawed back more than 80% of its losses at one point.
However, the worst may not be in the rearview mirror. Although the stock market has historically bottomed out well before the U.S. economy finds its trough, there are 10 feasible reasons the stock market could crash during the third quarter.
1. A second wave of COVID-19 forces additional shutdowns/business closures
Perhaps the most logical reason we could see stock market crash round two is due to a resurgence in COVID-19 cases. The U.S. is home to more than a quarter of the 10 million cases that have been confirmed worldwide, and recent days have shown a record daily number of coronavirus cases in the United States. Though President Trump has vowed not to shut the economy down again, this won't stop individual states and/or counties from doing so, nor can it stop businesses from choosing to close up shop. Apple, for instance, has chosen to close stores in a number of recent COVID-19 hot spots.
2. Second-quarter U.S. GDP is far worse than expected
The stock market may also nosedive as we get a closer look at gross domestic product (GDP) from the second quarter. There's no question it's going to be abysmal, with the Atlanta Federal Reserve estimating that real GDP will fall 39.5% for Q2. Mind you, the Atlanta Fed's estimate has ranged from a decline of a little under 15% to more than 50% within just the past two months. No one really knows what to expect at this point, and truly horrid data could be enough to push the stock market over the edge.
3. Q2 earnings miss already reduced estimates by a mile
To sort of build on the previous point, it's worth pointing out that Wall Street isn't able to provide a bar for publicly traded companies to step over come earnings time. That's because COVID-19 caused most stocks to withdraw their guidance for the year. Without this guidance, investors will have no choice but to examine ugly year-over-year comparisons.
Just take a closer look at what happened to Nike (NKE -11.86%) last week. The footwear and sporting accessories giant reported a fiscal fourth-quarter loss of $0.51 per share when a profit of $0.04 per share was expected. Even though digital sales soared 79% on a constant-currency basis, Nike's total sales face-planted 38% (36% on a constant currency basis). Without clear guidance, investors could be in for big surprises in Q3.
4. Public companies pull back further on dividends and buybacks
Another reason we could see the stock market roll over is the rapid decline in corporate share buybacks and, to a lesser extent, a slowdown in dividend growth, if not an elimination of payouts altogether. The Federal Reserve has put its foot down on bank dividends in the third quarter (i.e., they can't be higher than in Q2), as well as suspended bank stocks from buying back their own shares. Meanwhile, airlines have cancelled their dividends and buyback programs in order to get their hands on federal bailout money. Without these shareholder-friendly capital returns, investors may head for the exit.
5. The end of enhanced unemployment benefits
Don't overlook the potential for the end of enhanced unemployment benefits, tied to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, to undo the stock market.
The CARES Act provides a $600 per week added bonus to unemployed beneficiaries for a four-month period between the end of March and the end of July. With this financial lifeline set to expire in a month, the ability of the unemployed and their families to meet their financial obligations will be precarious, at best. And, as a reminder, it could take years for unemployment levels to return to normal.
6. A rising wave of mortgage delinquencies
To add to the above, a sixth serious concern is that we could see a surge in mortgage delinquencies in the foreseeable future. Most banks and credit unions have allowed their lenders some degree of forgiveness given the unprecedented nature of the COVID-19 pandemic. But, ultimately, there comes a time when landlords and lenders need their income stream back. Without additional stimulus from Washington, D.C., we could be in line for a showdown between homeowners/renters and landlords/lenders... and it may not end well.
7. Auto loan delinquencies soar to decade highs
It's also possible that, instead of mortgage or rental delinquencies being the tipping point, auto loan delinquencies become the culprit. According to the American Bankers Association, auto loan delinquencies were already at an eight-year high as of the fourth quarter, well before the pandemic fully hit the rest of the world. Though the auto market is nowhere near as large as the mortgage market, a wave of defaults would still put a hurting on bank stocks at a time when net interest income is falling and delinquencies are rising across the board.
8. U.S. China tensions hit a boiling point
Just in case you've forgotten, that little trade war between the U.S. and China isn't over yet. In spite of a phase 1 deal being agreed upon in mid-January, supply chain issues caused by the COVID-19 pandemic have not helped eased tensions for either country. It would certainly not be out of the question if retaliatory trade measures were used by President Trump or Chinese President Xi Jinping to compel cooperation from their opposition in securing the next phase of a trade deal. Any sort of trade war escalation would be bad news for the stock market at an already tumultuous time.
9. North Korea concerns reignite
Though it might be the least concerning of the 10 reasons on this list, don't underestimate the possibility that the world has to start worrying about North Korea, once again. Tensions between North and South Korea have been rising in recent weeks, and President Trump has been unable to get North Korean leader Kim Jong Un to agree to a denuclearization deal. While it's not unusual for tensions between North and South Korea to ebb and flow, something as simple as a weapons test from North Korea could be enough to set the world on edge.
10. Joe Biden seizes the reins in the presidential race
Finally, it's quite possible that politics could send the stock market crashing during the third quarter. To be fair, political moves in the market tend to be very short-lived. But if Democratic Party presidential candidate Joe Biden does begin to pull away from incumbent Republican Donald Trump in polls, the stock market isn't going to be happy. Biden has vowed to partially roll back Trump's signature tax law (Tax Cuts and Jobs Act) that slashed the corporate tax rate to 21% from 35%. If that happens, corporate earnings will rebound at a potentially much slower pace from their COVID-19 trough.