Putting a market recovery into perspective

We’ve been speaking to many of our clients the past several weeks regarding our thoughts, projections, and perspective on the stock market activity as a reaction to the COVID-19 crisis. As the full picture of the economic impact becomes clearer, though not entirely transparent, we are seeing some classic patterns in the stock market begin to emerge. In particular, a settling of volatility and potential for value re-tests.

In this chart of the S&P 500 since Feb. 2020, you can see a reduction in dramatic short-term moves caused by the initial uncertainty of our COVID-19 new reality when comparing the market from Feb. 20 – Mar. 21 versus the period of Mar. 21 – May 15.

This is very common in an event-driven market downturn in which a large percentage of the market loss is recovered very quickly, then moves relatively sideways for a period. During this time, it is advisable to evaluate opportunities for new investments as well as a reduction in some holdings. Just as the market downturn impacts all investments (good or bad) the recovery can also include some investments that may no longer have as much long-term potential.

The work our investment committee has been doing includes efforts to identify those holdings or allocations that could be mispriced and to adjust accordingly. Consequently, you may have noticed a higher volume of trading confirmations in your inbox.

Another typical market action to be aware of is a re-test of prior lows. In most other events similar to the current market volatility, the market will experience a period of “profit-taking” after the initial push upward. Often, these secondary downward moves are not caused by new negative event information. Instead, they are influenced by trader activity and rotation of investment focus. The higher level of selling can influence the herd and bring in more sellers, resulting in a post-shock tremor.

This next chart, also of the S&P 500, shows a longer time perspective. Here, you get a better view of the downturn and recovery described above, including the dramatic nature of the downturn and the present recovery phase. It is not our expectation that this recovery will continue to be V-shaped, but rather, a multi-week process that could include many less severe pullbacks.

Of course, some events could change this expected pattern. On the positive side, a faster-than-expected re-opening of businesses or a COVID-19 cure would accelerate recovery. On the downside, major spikes in cases, or delays in a vaccine, would likely cause a sharp decline.

However, in the absence of new material information, we are expecting market low re-tests and continued upward surges in an unpredictable fashion. As that recovery pattern proceeds, we continue to focus on fundamentals, like quality balance sheets and brands and services that can excel in this new reality. We also caution against the urge to sell or take your allocation above comfortable risk levels in pursuit of perceived bottom-fishing opportunities. We will continue with our focused evaluation of the markets and make suitable moves that add long-term value.