Stocks are tumbling Thursday, as investors grapple with heightened risks to the economic recovery.

There are signs that coronavirus cases are rising in more U.S. states and other countries, while Federal Reserve Chair Jerome Powell has emphasized the long, slow path back to previous levels of employment and economic activity. And another fiscal stimulus or support bill from Washington may be much smaller than some had previously assumed.

None of that means a second wave of the virus is here or that new economically destructive stay-at-home orders are imminent. Reopening progress and resumption of economic activity continues to accelerate. And the fact that the economy might not need as much fiscal support should be a good sign.

But it does mean that investors are moving to price in greater odds of negative scenarios. And after a more than 40% rally off the bear-market low in late March, the market’s outlook was decidedly rosy.

“The problem is [coronavirus] cases moving higher at the same time that investors are expecting another wave to hit (because of the protests) in a week or so,” Dennis DeBusschere, head of portfolio strategy at Evercore, said on Thursday. “If behavior changes as a result, the recent economic momentum will stall and fair value estimates move lower. Plus markets have to adjust for the possibility of a tail event. That doesn’t mean a tail event is the base case…just that markets need to adjust for it.”

The S&P 500 was down 5.2% Thursday afternoon, its biggest drop since mid-March and the first string of three consecutive declines since March 9. The Dow Jones Industrial Average tumbled 1,600 points, or 6%, and the small-cap Russell 2000 index lost 6%. The Nasdaq Composite fell 4.5% from the record it set on Wednesday.

And the declines were broad. About 490 of the S&P 500’s components were in the red, as all 11 sectors fell.

If second-wave fears are realized and the economic recovery is significantly set back, then stocks are likely still too expensive. But the drop Thursday could just as easily become a chance to buy the dip for investors who missed some of the blistering rally since late March, if rising cases level off.

The factors that boosted the market in recent weeks are still almost entirely in place: A flood of liquidity and low interest rates from the Fed, incrementally positive incoming economic data, and consumers and corporations adjusting to life and business in a coronavirus world. They continue to point to improving corporate earnings and justify high valuation multiples.

But the Covid-19 case data will be particularly important in the coming weeks. How the numbers respond to reopenings under way in all 50 states was always going to be a key catalyst for the market. The early returns are far from disastrous, but less than perfect, and stocks are moving to reflect that. Expect trading to remain choppy until the longer-term trend becomes clear, and for uncertainty to weigh on valuations in the meantime.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com

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