Numerous opinions have been offered on the probable outcome of the current crisis. Of course, the ultimate path cannot be known. Predictions have ranged from as much as 60%+ of the population becoming infected by the virus and lasting 18 months, in contrast with the notion that the worst may be behind. Most likely the outcome lies in between.
What may be more instructive for investors is some perspective of past crises. In examining more modern crises beginning with the “1987 Black Monday” to our current situation, there are some interesting observations to reflect upon. Every crisis has its own unanticipated catalyst. Of course, this is the reason for the crisis, and if markets had anticipated the event, it would ultimately have been reflected in market pricing, whether portfolio insurance of Black Monday, extreme valuations of the Tech bubble justified by the seminal event of the internet age, new derivatives magnifying the mortgage bubble resulting in the Financial Crisis, or our new current pandemic crisis.
What is unique about our current situation is that unlike the past events, this is not so much a “man-made” financial event but a natural phenomenon. We think it is fair to say modern markets have never encountered such an unpredictable situation. Perhaps this speaks to the unprecedented rapid decline in market prices and collateral random price movement. Clear contributing factors to the mayhem are the age and magnitude of this long bull market combined with the “indexation” of the market, making this somewhat of a “Perfect Storm.”
Three Modern Bear Markets
Despite the unique nature of each bear market, it may be interesting to draw some observations as we examine three “modern” bear markets.
As we look at our current bear market, its pattern, at this point, would seem to most resemble the “Black Monday” of 1987, specifically because of the waterfall nature of the decline. The 1987 bear market was relatively short-lived and bottomed in a relatively quick fashion. It is important to remember, however, that the catalyst (portfolio insurance) arguably had little effect on the overall economy.
In comparing the Tech Bubble crash, there are also similarities in that this decline followed a long bull market not unlike the one that began in 2009. The Tech Bubble bear market included a recession arguably exacerbated by the attacks of 9/11. In total, this market took roughly 29 months to bottom, and the subsequent rally, which lasted until 2007, was relatively modest.
The Financial Crisis of 2008-09 also may have common elements to draw upon. The survival of the financial system was the primary fear and resulted in an 18-month recession. The market took approximately 17 months to bottom from the November 2007 peak. What was unique about this period, and may have similarities to our current environment, was the massive stimulus that followed, which ultimately propelled the markets during the most recent 11-year bull market.
While the current market pattern may most resemble the waterfall of 1987, the economic impact of our current situation could approach 2008-09, as we are likely to rapidly move into recession, the duration of which is difficult to gauge. One also has to wonder about the long-term effectiveness of a second round of massive stimulus.
Currently, the market is attempting to make at least a short-term bottom. Despite the fact that we may see sharp moves to the upside, we expect this process will take time. The current economic damage seems less likely to suggest a V-shaped bottom, and we lean toward the notion that this bottoming may take more time. Maybe not the 28 months of the Tech Bubble, but perhaps as many as 3-12 months. While economic stimulus should limit the damage, we do not expect this dose to be as effective as the initial round in 2009. Additionally, given the recent “indexation” of the market combined with current algorithmic trading, we should continue to expect out-sized random price moves.
The Good News
The good news in the midst of this storm is that the market will ultimately heal itself. There is opportunity in the mayhem. In this environment, we continue to believe our focus on stable earnings, lower price volatility and favorable valuations will be rewarded as this plays itself out. We are reevaluating the stability of earnings in the context of this environment, focusing on favorable valuation and seeking relatively lower volatility in a period of extreme price movement.
As investors, we must be flexible in a rapidly changing environment, recognizing that the past is not always prologue.
Sources: Factset, Ned Davis Research
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