Insight
Coronavirus Quick Takes March 31, 2020
April 1, 2020
Welcome to day three of Coronavirus Quick Takes. Today let’s tackle the question that every investor is asking: How long will it take for stocks to recover?
Lacking a crystal ball, we will try to give our best estimate based on history and what we’re seeing in both the markets and the economy today. While we know that history never repeats itself, Mark Twain reminded us that it does rhyme, and we can develop some ideas about what to expect in 2020 based on prior periods that appear to share some characteristics with today’s events.
Bear markets are often divided into 3 flavors: cyclical, structural and event driven. Cyclical bear markets are the most common and typically occur when central banks raise interest rates to combat inflation, but then overshoot and push us into recession. Although we haven’t experienced one of these since 1990, they represent the majority of bear markets since 1835: 15 out of 27, or 56%. During a cyclical bear market, stocks typically take 2 years to reach their lows and another 2 years to regain their old highs. Given that interest rates were already falling before the market started its decline, this bear market does not appear to be cyclical.
A structural bear market occurs when something is awry in the financial system. The 2000–2002 and 2007–2009 bear markets were both structural in nature. The more recent one was triggered by excessive leverage, both in the banking system and elsewhere (similar to what happened in 1929–1932). The dot.com bust of 2000–2002 represented a massive misallocation of capital and an equally enormous bubble in equity prices. These types of bear markets tend to be long and severe, with stocks taking an average of almost 4 years to reach their lows and another 6 to regain their highs, and are typically accompanied by lengthy recessions. Again, the current bear market does not appear structural in nature. There have been a total of 7 structural bear markets since 1835.
The third type of bear market is caused, as its name implies, by an unexpected shock to the system that may or may not lead to a recession. We have had 5 such bear markets since 1835 (not including the current one). The main difference between this kind of bear market and the more common cyclical one is less in the degree of decline in stock prices and more in the rate of the fall and the speed of recovery. Both of these tend to be faster in an event-driven downturn: 9 months on average for stocks to reach a low and only about 6 months more to get back to their starting point. Thus, in an “average” event-driven bear market, the time from the start of the decline to full price recovery is just over a year.
At this stage, the current market certainly looks like an event-driven bear market, with the spread of coronavirus around the world being the obvious trigger. However, there are some caveats here:
- None of the previous event-driven bear markets were triggered by a disease outbreak. Typical triggers have been geopolitical or internal to the financial markets. While the 1956–1957 bear market did overlap with the 1957 influenza pandemic, the cause of the former was geopolitical and stock prices had almost completely recovered by the time the virus hit US shores.
- The economic slowdown that accompanies the current bear market is unique in that never before have large swaths of the economy been deliberately shut down. While the economy can be voluntarily “restarted” at any time, when countries decide to do this will depend on the course of the coronavirus, which is only partly predictable.
- Central banks’ toolboxes are somewhat more limited going into this slowdown because interest rates were already at very low levels.
At least partially offsetting the above caveats is that never before have central banks and governments around the world reacted so quickly and forcefully with financial and economic backstops and stimulus programs. And it does appear that if the partial shutdown extends for more than another month or two, further stimulus programs are likely to be introduced. In fact, the White House and Congress are already discussing another stimulus bill that could be up to another $2 trillion in size, even if the shutdown ends before June.
While there are no guarantees with the economy or the markets (or in life), it does appear that the current bear market and economic slowdown, while sharp and scary, may also be relatively brief, ending in the span of months rather than years. At the same time, given the highly charged emotional nature of the current environment, it may feel like years.
For our next edition of Coronavirus Quick Takes, ask us a question and we’ll do our best to answer it.
Yours truly,
The KCS Wealth Investment Team
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