By Daniel Lanyon
The spread of Covid-19 is bringing more questions than answers and the full ramifications may take years or even decades to unfurl. The most immediate effect, for those lucky enough to have not been a victim of the deadly virus directly or indirectly, is economic and financial in nature and is happening right now.
Daily life has changed beyond all recognition, at least in the short-term. The chances are much of your stock portfolio has gone red and you’re left wondering, what now? Should you sell, buy or sit tight and do nothing?
For many investors, especially those under the age of 35, this is likely to be their first experience of a market crash, however it is both a fast-moving and unnerving time for everyone. Comparisons with the Global Financial Crisis in 2008 and the Black Monday crash in 1987 have been made. With things developing so quickly, uncertainty is currently the only dominant state.
The world is dealing with a pandemic that few saw coming or had fully prepared for. Until fairly recently, for those people outside of China, it also felt relatively unthreatening. Now, the situation is far more serious than anyone predicted and the risk of a global recession is looming alongside infection. Over half of the world is in lockdown, with schools closed for the foreseeable future and economies going into free fall. While in hospitals, the human cost is clear for all to see as the death toll reaches staggeringly grim new heights. Huge moves in the stock market are unsurprisingly becoming a regular occurrence.
Where we are and how we got here
It’s been a particularly wild and rough time too for investors in the stock market in 2020. The spread of the coronavirus, which causes the sometimes fatal respiratory disease Covid-19, is the main reason for the extreme volatility.
There have been violent moves up and down in stock markets, particularly since the oil price crashed 30% on 9th March. This unexpected consequence of the crisis, started by a spat between Saudi Arabia and Iran over the oil supply, made investors even more jittery. More unexpected events seem likely.
The coronavirus pandemic has brought an end to the longest bull market in history and we are now in an official bear market. In case this lingo is new to you, no animals are actually involved but it’s an important term to take note of nonetheless.
A ‘bull market’ is when broadly things are going up in a sustained fashion. The most recent bull market began some time ago; 11 years almost exactly when the S&P 500 reached its lowest point (investors often call it the ‘nadir’) during the financial crisis on 9th March 2009. The length of broadly upward movement means it was the US’s longest bull market on record, with the index rising nearly 400% from that day to 19th February 2020.
A bear market is the opposite movement. It is usually taken to mean a minimum 20% fall from the market’s last peak. Between 19th February and 12th March 2020, the S&P 500 index fell 26.7%, the shortest ever time period it has taken for the market to fall into a bear market. The following day the market leapt up more than 9%, but this extreme volatility only increases nerves and shows just how volatile things are at present.
Going on a bear hunt
Every market crisis is different but – so far – all have eventually provided an opportunity at some point to buy stocks very cheaply and make a profit for the long-term investor when the market rebounds and the next bull market begins. Although, this can take several years at times and it is important to take a long-term view in holdings.
These are confusing times, though. The worst could still be ahead. Many investors will be asking themselves whether to ‘buy the dip’ or whether we will see a ‘dead cat bounce’ and should they ‘beware a falling knife’. Don’t worry, we will unpack these three well-known (admittedly strange) investment phases in a bit to better understand the risks and opportunities in a bear market.
For the long-term investor, the question has to be when selling has become too much and value starts to appear. For those new to investing such falls are unprecedented. Since the 2008 crisis brought stock markets to their knees and a global recession to the real economy, US stocks have broadly moved in one direction: up.
Over the past few months we have seen a rollercoaster in stock markets. The initial sell-off was very big indeed but so far we have seen an extraordinary partial bounce-back, with investors ‘buying the dip’ i.e they have bought shares in the stock market when it has gone down believing that the market will go up again soon.
There have been huge moves up and down in single trading sessions. For example, on 24th March, Wall Street (and global markets more broadly) had a day to remember. The S&P 500 surged more than 9%, with many stocks rising more than 20%. These included the likes of Norwegian Cruise Line Holdings (42.19%), Victoria’s Secret owner L Brands (39.04%), DXC Technology (41.02%) and American Airlines (35.8%) which led the charge in the US market.
Why did markets react so positively in just one day? Because an incredible $2 trillion rescue package was signed off by US Congress. Markets typically love this sort of thing.
Amid all the uncertainty about how the coronavirus will unfold, this is an important thing to note when looking at stock markets. Investors are closely watching the response from governments and central banks in terms of how much cash they are willing to splash and the lengths they are willing to go to prop things up.
When the Federal Reserve, (aka ‘The Fed’), pumped money into the system in 2008, markets rallied as they did in March this year when the central bank pledged unlimited support for markets. There is a well known saying on Wall Street: “Don’t fight the Fed” – meaning don’t trade against how it acts.
It is worth noting that the US stock market is still down from where it was before 19 February (and the market began to fall) by around 20% (at the time of writing). This is a substantial amount. Markets have made several big one day gains but many companies have yet to report how they have been affected and the virus continues to spread.
The danger in this scenario is whether we might be in for a ‘dead cat bounce’. Don’t worry: again, no animals are involved. This is where an early crash followed by a quick rise is not the first steps of a proper recovery but rather a misstep by some investors ahead of further and deeper falls in the future.
It is very important for all investors to remember that a crisis of this magnitude has multiple effects or waves. We are still in the very early stages from the point of view of the real economy. More bad news is likely to be around the corner when the true damage to jobs and industries is clear.
Another danger is where you buy a stock after a big fall only to see it fall further still. This is called ‘trying to catch a falling knife’ as for example, after a stock falls 80% from its last high, a further fall to 90% from that high means that you will have lost half your money if you’d bought at the 80% level.
As investment bank Schroders’ Chief Investment Officer Johanna Krykklund said recently: “it would be unwise, even glib, to dismiss the risks of this crisis.”
The bursting of the technology bubble in 2000 and the 2008 global financial crisis saw stock markets fall up to 50%, meaning that if these levels are repeated more pain for investors could be on the way. Some, such as the former governor of the Bank of England Mervyn King (now Lord Lothbury) have said the coronavirus pandemic is an even bigger economic challenge than the 2008 financial crisis.
Volatility: the good, the bad and the ugly
One of the reasons why the market falls have been so quick and severe is relatively simple. You won’t need Margot Robbie in a bathtub (as she does in the Big Short) explaining complex financial products with confusing acronyms. It can be summed up in much easier to understand terms.
The coronavirus pandemic hit markets when they were at expensive levels, particularly in the US. High valuations, after an 11-year bull run, are arguably likely to make sentiment more precarious and vulnerable when an event such as the coronavirus pandemic comes along and hits the stock market.
Volatility is not always a bad thing, though. Markets usually do and probably will recover at some point. However, when this will happen is very hard to understand or predict, given the rapid development of the virus. If you want to find good quality companies to invest in at cheap prices though you generally have to be prepared to buy stocks at a time that most others think is undesirable and be prepared to hold onto them for the long-term.
“The time to buy is when there is blood in the streets,” is an investing maxim attributed to Baron Rothschild in the 19th century, (although there is scant evidence of him actually saying it.) Nonetheless, it is meant to explain the reality that markets bottom out in a crisis before the economy is fully back on its feet. Therefore, buying when sentiment is at its lowest point tends to make sense.
Of course, we’ve not had anything so bad as that yet. Rothschild was investing 200 years ago around the time of the Battle of Waterloo, but at the time of writing the rapid increase in COVID-19 deaths and empty shelves in supermarkets are very, very stark. Could further falls be on the cards? It would be a brave investor who could rule it out.
What comes next?
Coronavirus is a global pandemic and the longest bull market in history is definitely over. Further falls cannot be ruled out and therefore moving too early could be a mistake. However, purely from a valuation perspective, the share prices of many well-known companies have fallen to levels not seen for several years, from American Express to American Airlines, Alphabet (Google) to Disney.
Given the risks that further unexpected twists and turns may be ahead, caution might be a good starting point of view until the fog clears. This is a market where we are all in uncharted seas. Waters are very choppy but under the surface, opportunities may be waiting.
Daniel Lanyon is a financial journalist and editor-in-chief of AltFi. You can follow him at: @djlanyon
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