After a staggering 35% drop from peak to trough, the US markets would need to rise back roughly 54% in order to get back to the previous high. Last week, between March 24th and 26th, the S&P500 spiked higher by 20% providing a much needed relief for investors. This has left market participants wondering whether the lows of this bear market have been set and whether we could possibly see a V-shape recovery.
Calling the bottom has always been a near impossible endeavor. Although we are pleased with the midweek reprieve in selling, we are hesitant to get too excited as we recognize some of the biggest rallies in history have come during bear markets. When looking at the S&P500 chart between 2000-2002, there were six bear market rallies and three of them were over 20%. Ultimately, the market didn’t bottom until October 10 2002, delivering a near -51% drop measured from peak-to-trough. As often is the case, the "bottom" is more of a process rather than a single point in time to detect.
The VIX (a technical measure of volatility) has come off the extreme reading of 85 to the mid-60s, however, that level itself still signals an acute amount of volatility. We remind investors that volatility is experienced on both the up and downside. Our team braces for the market to potentially test the recent low of 2191 on the S&P500. Although a re-test of the low is not guaranteed (after all, we never did retest the March 2009 lows of the financial crisis), history does tell investors that it is not uncommon.
The first quarter of 2020 has yet to come to a conclusion, and it appears that North America is just beginning more robust Covid-19 testing, which will surely bring startling reports of new cases. Therefore, we question whether the market can bottom before the number of Covid-19 cases tops. Admittedly, the worst news and headlines on the health care front have yet to be seen.
Understanding that the market bottom is a process, we must recognize the progress and silver linings where possible. Positive developments may not provide immediate firmer footing for the market, however, headlines and sentiment changes gradually by accumulating more constructive data. We feel it is important to note that in the last week, the markets received something that it was starved for – just a little bit of clarity. Prior, it was uncertain as to what the Federal Central Bank would do to assist the economy and how big of a stimulus package would be passed by the House. Now, investors understand the meaning of the ‘Whatever it Takes’ movement, with ‘unlimited QE’, emergency liquidity programs and a $2trillion Coronavirus stimulus bill. In aggregate these measures are considerably more substantial than anything seen during the 2008-09 financial crisis. As a result, the Fed is committed to averting a credit crunch and liquidity has returned to the fixed income markets as evidenced by gradually declining spreads and yields in corporate and high yield bonds. Although this clarity was much needed, it will not single-handedly bring markets back to its highs, however, it is one solid brick to a firmer path.
Another ‘brick’ worth mentioning is that it appears that the market has worked off some oversold conditions. Joshua Brown, CEO of Ritholtz Wealth Management in New York City, recently commented that just over a week ago, 95% of stocks were below their 10-day lows, and as at the time of this writing, we now have zero at these levels. That being said, only 2-3% of stocks are above their 50-day, so the damage is still very real. Much of the extreme selling witnessed in March has partly been attributed to the indiscriminate selling of machine and algorithmic trading platforms. However, investors can now see more fundamental investing patterns forming as certain stocks within the same sector rebound at different speeds and the relatively more oversold sectors showing interim outperformance. With that said, correlations are still high and markets are still gripped by emotion.
At this moment, we recommend investors to review their portfolios and take the time to rebalance portfolios and upgrade the quality of the stocks being held. This could mean, making adjustments to get portfolios back to the long term target asset mix. It could also mean reducing exposure to the more cyclical sectors that underperform in recessionary environments and into the more defensive dividend-paying sectors. Moreover, secular growth stocks that can report sustainable earnings growth above economic growth should also be reviewed.
We remain cautious in this investing environment. We will be monitoring whether the recently announced stimulus from the Fed and House are efficiently and effectively implemented. Signs of government breakdown could justify derisking the portfolio further. As for data, other than tracking the potential peak in new Covid19 cases, we will pay particular attention to the manufacturing, service and unemployment data released in April which will appropriately reflect the damage that began in March. Although few investors would outright refuse a V-shape recovery, the positive long term outlook for equities and valuations remain intact, and therefore patience throughout the bottoming process is still the most valuable asset for investors.