As I prepare for each week, I like to do my own recap of the markets. I look at trends over the last week and scale it back to the month and quarter to see how the big picture evolves. Even though everyone is linking the market depression to COVID-19 (which is fair), I thought it would be an interesting opportunity to look at the previous market fluctuations and evaluate how this one compares.
I found a great article from Forbes that breaks down different recovery patterns, and I thought this would be a good place to summarize it and give my impressions.
There are four common shapes to describe market recoveries. The “V”, “W”, “U”, and “L”. The “V” and “W” are the most common, because the “U” is really a variation of the “V”, and the “L” is very uncommon. But let’s start in alphabetical order.
The “L” is associated with a worst case scenario. As the shape implies, there is a sharp drop in the market which doesn’t recover, or at least takes a long time to transition to an upward trajectory. This shape hasn’t been seen in a long time, but most recently appeared in the 1990’s in Japan, known as the ‘lost decade’.
If we look backwards in time, we’ll see that the “U” shape was a part of some of the bigger market events. It depicts a downward movement followed by a “bottoming out” period. This shape is seen through the Great Depression, as well as some of the market events in the late 1900’s. The “U” illustrates an economy that has declined without an individual stimulus of recovery. It leads to a slow incline in the valuations of the market rather than a stark climb.
The “V” is a more common variation of recovery. It represents a sharp decline and a quick ascension back to original (and most often higher) values. It is more likely that the contraction and expansion are a result of an outside factor. For example, in 1952, when the market was still ‘booming’ after the Second World War, the US Federal Reserve raised interest rates in the anticipation of disproportionate inflation. This caused a “V” recovery from Q4 1952 to Q1 of 1955.
Most people who are preparing for retirement remember the crash of 2008 vividly. The Lehman Brother’s went under and the economy fell in hot pursuit. Hindsight being 20/20, we can see the market crash of ’08 as a representation of a “W” recovery pattern. In the late stages of ’07, there was a relatively small and quickly resolved market depression followed by the major fall halfway through 2008. The minor correction combined with the major event form a “W” pattern.
So, what does this tell us?
Having knowledge about the ABC’s (or rather UVW’s) of market recovery is only helpful if we can apply it. Unfortunately, we can’t see a pattern until after it has appeared and it has joined the rest of the recoveries as part of our history. That being said, we can look at the behavioral patterns of people and how the COVID-19 pandemic varies or resembles patterns seen before/during previous market disruptions. Experts would agree that the market behavior would best point toward a “V” or “W”, but only time will tell. The rational for the “V” is that once we are allowed to mingle in public again, people will return to stadiums and restaurants, causing a quick surge of money flowing in and out of the economy. Specialists fear a “W” recovery if governments re-open the economy too soon. The news has mentioned the idea of a ‘second wave’ of Coronavirus stemming from healthy individuals returning to ‘normal’ and interacting with asymptomatic people. This would cause a second impact of new patients in hospitals, and see governments re-think their strategy, having potential economic consequences.
If we self-isolate and flatten the curve, a “U” shape could emerge. This would be caused by a slow and strategic introduction of economic stimuli. It could be even more pronounced if people were to be skeptical at first. Imagine the governments fully opening markets trying to create a “V” response. People are still fearful and decide to continue the limitations on their interactions. This means there is a slow and steady increase to economic activity rather than an ‘opening the floodgates’ response.
All that being said, we can’t predict what the market will do. People have been trying to time the markets for decades. And some have made careers out of it. It will be interesting to see how this plays out. I imagine that whichever way it pans out, this will become a unique lesson for us all to learn from.