Investors are not really sure about how to manage the Corona Health Crisis of 2020. To this end we have cut through the noise and summarised all of the major US bear markets since 1929 in one graph, to give you a clear perspective on what is happening. Here are the peak-to-trough falls and how long they lasted:
The left hand y-axis represents the stock market price re-based to 100, for each given time period. The x-axis is the length of time, in months, that the crash lasted.
We have heard a lot of comparisons between 2020 and the market crashes that happened in 1929, 2001, and 2008. Unfortunately in all three recessions shares fell between 45% and 83% from peak to trough. At the moment the S&P 500 is 31.9% off the high it reached on 19th February 2020. It would be prudent to expect at least another 13% fall, at the very least, before we see the bottom.
What you may notice right away on the graph is a clear trend: if economic turmoil follows this crisis, then in the coming weeks we could potentially see another 20% decrease in the stock market indexes.
How can you tell?
The daily and to some extent weekly gyrations are meaningless. Millions of retail investors and some big institutions are buying and selling shares en masse, which is driving volatility to unheard of levels (the VIX measures volatility and hit the highest reading ever this week). As we cover in the Market Timing Model we need to see a sustainable reduction in volatility before we buy this market.
I spoke to my broker yesterday and he said that they’ve had to call in new workers just to cope with demand. At the moment trade volume, call volume and activity has gone through the roof! People are frantically trying to speculate on the short term direction of the market and missing an obvious point.
There is a sharp, downward trend that is unparalleled in history and it is important to recognise that we are in unchartered waters. Imagine that these trends are like gravity: until we have certainty on earnings and unemployment, and a clear picture of the end of the health crisis, it will continue to pull down asset prices.
Interpretation of the Data
In every other past “major bear market,” defined as a sharp fall of 30% or more, there was at least another 20% to go before the bottom.
As we discussed last week corporate earnings and unemployment are what’s known as lagging indicators – they happen after the market has corrected. So once they get released to the public it impacts the valuation of businesses, and it is impossible to say how bad they will be until they come out. Investors trying to invest in equities now need to realise how much risk that involves (hint: it’s a huge risk!)
You need to follow the unemployment data and corporate earnings data and – do nothing until it stops falling. Use it as your main guide and compass. This is easy to do, in theory, but requires a real concerted effort to “hold off” buying stocks. The real winners at the end of this mess will be the stoic, careful, and fact based investors who use the information around them and act on reason rather than emotion or instinct.
Former Trump advisor Gary Cohn has warned that the US will have “massive unemployment, very, very quickly.”
He is joined by Goldman Sachs who predict that between 2.0-2.3 million people will have filed for unemployment benefits when the numbers are reported this Thursday. If that sounds like an unbelievable figure let’s have a look at past recessions:
Unemployment is a figure that can, and does, rapidly rise during times of economic duress.
In the United Kingdom the consultancy Capital Economics believes that 700,000 jobs are at risk, causing the unemployment rate to reach 6% this year. That factors in the government intervention with wage subsidies and financial easing.
When it comes to asset prices the real market carnage tends to happen when unemployment rises sharply and corporate earnings fall as the bad news gets reported on.
In all of the major recessions (1929, 1973, 2000, 2008) it wasn’t until we hit peak unemployment and bottomed out in negative earnings updates that the stock market truly hit a bottom. It is imperative that we get sight of the figures over the next few weeks and re-calibrate after that.
(2) Corporate Earnings
Corporate earnings are going to be absolutely decimated between April 2020-June 2020 at the very least, and quite possibly for the rest of the year. The stock market and equity prices are driven principally by corporate earnings that businesses report on, in general, quarterly. If there is an earnings recession, then tens of thousands of analysts are going to lower the price estimates for stocks. When they do that the stock market will continue a second and third wave of selling, as dividends and share buy-backs are slashed and forecasts revised lower.
Let’s learn from history, because this has all happened during past market crashes.
To show the importance of following corporate earnings let’s see when they bottomed out in past market crashes. Look at the red lines on this graph, which represent the moments in history when corporate earnings stopped falling:
Notice how the red arrows, which represent the lowest readings on real earnings for the stock market, tend to come right around the absolute market bottom? This isn’t a perfect science, however, it would have enabled you to get within +/- 10% of the lowest point in the market.
In fact the only major bear markets where the market continued to fall well beyond the drop in real earnings was the 2000-2002 Dot Com Crash, and the Great Depression.
Possible Economic Outcomes
If you look at the red dotted lines in the above graph, they represent two outcomes of the Corona Health Crisis 2020 and the subsequent returns for stocks.
Scenario 1: the stock market recovers, like it did after the initial fall in the Great Depression, because we find a miracle cure for the virus. Corporate earnings remain intact and by the end of the year we experience a “v-shaped” recovery. Up until last week I think that this was the consensus view of the market. Unfortunately this now looks like wishful thinking and there is a very low chance that this happens.
Scenario 2: the stock market corrects another 20-25% from 21st of March 2020 levels, as corporate earnings come in and the GDP figures reach generationally-bad levels of -5% to -8%. The Coronavirus peaks by June/July in most developed countries and we start to see evidence of a cure before the end of the year. The economy hobbles along with hand-outs from the government and people start to return to work. We don’t beat the virus fully but society regains control and sets itself on a course to recovery.
Scenario 3: the stock market has a Great Depression style fall and corrects another 40-50%. The bond market implodes and corporations start to default on their ballooning debt loads. The virus gets worse and healthcare systems get overrun. We get a dose of bad news because the virus’ cure is further away than we think. The banking system is on life support and needs a “new deal” in order to be saved. Expect a lost decade for stocks and pretty much any other risk asset, and a very long, slow recovery over 10-20 years.
Instead of watching the stock market and prices itself, start to engage with corporate earnings reports and in particular the weekly and monthly reports regarding unemployment.
Follow the Market Timing Model for the latest update on a host of measures that have further predictive capacity for the stock market. There is both a Sentiment and a Market Value indicator that is worth following.
Finally, don’t panic. Read a book, take a long walk in an (empty!) park. These are worrying forecasts and they make you want to run for the hills. The key thing is to stay conservative, stay positive and look to the future after we’ve beaten Covid-19.