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Powell: Coronavirus is biggest shock to economy in modern times

Neuberger Berman Multi-Asset Class Chief Investment Office Erik Knutzen joins Yahoo Finance’s Seana Smith to discuss the latest market action as the coronavirus rattles the U.S. economy.

Video Transcript

SEANA SMITH: And we've talked about Fed Chair Jerome Powell's address from an economic perspective. We also want to talk about from a market perspective, and for that we have Eric Knutzen, Multi-Asset Class Chief Investment Officer at Neuberger Berman. And, Eric, it's great to have you with us this afternoon.

We take a look at the reaction that we're seeing in the markets today. The Dow now off over 500 points. What do you think investors are most concerned about today on the heels of those comments from your hometown?

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ERIC KNUTZEN: I think that investors are beginning to evaluate kind of the shift of what they're underwriting in markets. We've seen this very significant rebound in primarily US large-company stocks and investment-grade bonds off the bottoms in March, and that was really based on the tracking of the virus and the expectation of the virus peaking in April in Europe, in late April or even May in the United States, and the massive stimulus that was, you know, accompanying the crisis.

At some point, our expectation is that investors would have to pivot and start evaluating or underwriting the impact on the real economy, and now we're starting to see that. And what Powell's comments indicated is that there are, to a certain extent, limits to what the Fed can do, and they've done a lot. I agree completely with Professor Economides in terms of the positive impact of what they've done.

But at some point, either fiscal stimulus has to pick up the baton and extend the relief and support for, you know, people impacted by the virus beyond a month or two or there is going to be more lasting pain in economic fundamentals.

SEANA SMITH: Yeah, Eric, what do you think will be the next catalyst for the markets? Will it be some sort of fiscal policy? Is that what you think will be needed in order for the market to continue some of its momentum that we saw during the month of April?

ERIC KNUTZEN: I think the market is looking at the impact of reopening extraordinarily carefully. I agree with Professor Economides. The most important economic driver over the short term is going to be the degree to which the economy reopens, and the economy is reopening. It's happening. It's happening state by state, not in a coordinated fashion as you see in Europe or other countries but state by state.

What happens in terms of the levels of cases in Georgia, in Florida, in South Carolina, in Tennessee, in Texas, in other states as they begin to open up? If they stay flat or even decline as economic activity begins to resume, then markets can take heart. If, as the economy is reopened, you start seeing, you know, spiking activities in terms of cases, hospitalizations, there's going to be risks of lockdowns and a much slower recovery.

SEANA SMITH: And, Eric, at a time like this when there's so much uncertainty like you're saying-- we're trying to gauge whether or not we've seen a peak, what the next couple of months will hold. How are you-- how has this shifted your investment strategy, and how are you identifying opportunities at this point?

ERIC KNUTZEN: Sure. So we work closely with the senior investors across Neuberger Berman and our colleagues to identify what we call a crisis playbook where we identified three scenarios for how we could pass through this crisis-- our base case, a U-shaped recovery as Professor Economides indicated; a bull case, which was V shaped; and a bear case, which was more L shaped.

We believe that a month and a half post kind of the nadir of the markets in March, the economic information, corporate earnings, unemployment is consistent with the base-case view, 25% to 35%-- 30% drop in economic activity peak to trough in the US, 6% GDP-- negative GDP growth for 2020. There's a more modest recovery of economic growth in the second half of the year.

In that base-case environment, we want to be oriented towards large-cap, high-quality companies with a US orientation and investment-grade credit and higher-quality high-yield bonds, really going where the Fed's going. And that's our kind of all-weather exposure.

And then the other thing we're doing is we're trying to take advantage of volatility. We think that we will see the kind of volatility we saw late yesterday and today for some time to come. And so one way we're gaining equity exposure is through writing put options on the US, on the S&P 500, to basically get paid a very rich insurance premium on the willingness to buy equities at lower levels from here. It's a way to get paid in a high-volatility environment without taking as much downside risk.

SEANA SMITH: And, Eric, real quick, I just want to get your take on just what we saw on the earnings front over the last or several weeks. We're getting ready to wrap up earnings season. We've seen a number of companies withdraw their guidance, so not really giving us a great picture of what to expect ahead. But how are you incorporating that into some of your forecasts?

ERIC KNUTZEN: Yeah, our assessment is that we're going to see a 25% to 35% drop in S&P earnings in 2020 relative to 2019. That brings us to about $110 a share, down from $163, and then next year rebounding to $140, $145.

When you look at Wall Street consensus, it's come down to the low $120s, but it's dropping fast. And so we think it's going to converge to those levels, but we do see evidence that it's troughing as many upgrades as downgrades of forecast, more upgrades for cyclicals, fewer upgrades for defensives. So we think that Wall Street is kind of catching up to the magnitude of that shock that we're experiencing on the corporate sector.

All that said, at those levels of earnings, it's hard to make the case that the S&P 500 is anything other than fairly richly valued at these levels. We'd like to see some short-term pullback or more evidence of clarity on the pace of the rebound as the economy opens up before we add significant equity risk at this point.

SEANA SMITH: Eric Knutzen of Neuberger Berman, thanks so much for taking the time.

ERIC KNUTZEN: Pleasure. Thank you.