Two weeks into the lockdown in the UK, whilst I doubt that ‘normal’ is the correct word, general acceptance and tolerance is becoming more apparent.
There are some small rays of sunshine through the gloom, with a fall in infection rates and deaths in both Spain and Italy. Equity markets reacted in kind yesterday and have done so again today.
Nevertheless, with the extreme uncertainty surrounding the coronavirus crisis (particularly its duration), fear and the need for liquidity continues to dominate markets.
The general expectation is that, even with the impressive rallies we have seen, the ‘bear’ market in which we find ourselves has some way to run yet, but we may well have entered a different phase? Thus, it can be helpful to set out some sort of anatomy to a ‘bear’ market. John Rekenthaler of Morningstar believes that investors go through four emotional stages, akin perhaps to the Kubler-Ross/Kepler “Stages of Grief”.
Recognition: In the early stage of the sell-off, initial falls are seen as normal, and nothing to particularly worry about. However, as prices continue to fall and volatility continues to spike, investors become aware that this time might really be different, and that a quick loss can result in a permanent loss. The current bear market went through this phase at the end of February. Before then, markets were still up slightly for the year. Then, a sudden 11% fall made it clear that the cause for concern was real. Many investors still reassured themselves that these things happen, and volatility is to be expected, but markets failed to hold on to any of their gains.
Panic: Once the realisation sets in, it becomes clear that the usual advice of “buy the dip” is not working. Faced with risks where there are lots of unknowns, human nature is to do something, and quickly. “Sell first, ask questions later” becomes the dominant strategy. And most of the time, that means selling whatever you have. During this phase, rational analysis of future asset values is futile. Asset prices are not a good predictor of future earnings streams because they do not reflect future expectations at all; they merely demonstrate the need for short-term cash. This is the stage we were in for most of March, with losses continually compounded by ever-worse news on the coronavirus crisis.
Stabilisation: Eventually, the panic starts to subside, either because moods change or because the panicked sellers have nothing left to sell. However, overall sentiment remains fragile, and market rallies, even the most impressive ones, are short-lived. As such, it is a volatile and turbulent time, potentially stretching on for months.
The one redeeming factor is that the bleeding has stopped, and the end is more or less in sight. The rebounds have begun, but are unlikely to be sustained until there is a clear path out of the health crisis.
Anticipation: When the road back to normality opens up, stocks eventually start their recovery, but the news flow remains grim. It is, after all, always darkest before the dawn. The early recovery usually goes unnoticed by the general public, who are still focused on the dire short-term economic prospects. Long-term investors see improvement on the horizon, however. They make their bids, trading volumes pick up and prices begin to rise. For example, when the market eventually began to rally after the financial crash in late March of 2009, the global recession still had months left to run, and few believed that a market turnaround was already in train.
It is perhaps a brave person who feels that we have reached the ‘anticipation’ phase just yet, given rising death rates in the UK and United States; only our friend ‘hindsight’ will provide an answer to that conundrum?
However, there is a view, which is starting to gain credibility, that we may be in the ‘stabilisation’ phase?
If this is the case, this is good news as far as limiting losses goes, although it could well be a long and bumpy ride before things eventually get back to normal.
The main problem is that the potential for significant economic damage, the ‘tail risk’, is extremely difficult to estimate.
I do not profess to have the foresight to know where markets are heading at the best of times, but I am here to talk through and help you through this very difficult period in our lives.
Please do contact me if you wish to discuss any aspect of your finances; if you are considering selling some of investments through a fear of further falls in investment markets, to reinvest if you are holding cash as you can see an opportunity or just some reassurance that taking no action may prove to be the best strategy of all in the longer term.
In the meantime, please keep safe!