Consensus Building Over Stock Market Retesting Lows
We often look to history to try to see the future, and this especially applies to stocks. History can be helpful, but we want to make sure that we don’t try to replace the present.
As we continue to move further and further away from the stock market low that we put in on March 23, there are still a number of folks in the investment world that think that the worst is not over, that we will break through this low water mark with this bear market in the coming weeks.
The main thrust of this belief is derived from looking at past bear markets, where we do tend to see setbacks in the recovery that do have the moves completely break down and head further into the red for a while.
We often see a battle going on between the fundamental side, which looks at future expectations down the road based upon things like future earnings, and those who study charts and patterns, the technical side, and while the fundamental side does tend to dominate the thinking of analysts, we’re seeing them turn a curious eye toward the technical side, by their looking at bear market patterns and recoveries.
It is not that these folks are exclusively relying on these past patterns, as there is no shortage of concerns with the market these days, not the least of which is how slowly we may re-open the economy as we see the toll of this viral outbreak decline, as well as how bad of a hit that we’ll end up taking on the economic side from this.
However, what seems to be taking beliefs from just looking at the risk of a further low being made along the way to one that some people are remarkably confident about is our history of re-testing lows once we’ve put in an initial recovery from a big fall.
The pattern that is being relied on here presumably sees us engaging in a relief rally of sorts after a big decline, see how bad things actually are, and see that initial optimism get beat back as the reality of whatever mess that caused the first sell-off becomes more transparent.
Whether we realize it or not, this is venturing well into the territory of technical analysis, and if we are going to use this sort of analysis, we need to make sure that we use it well and not in a manner that may lead us astray.
Whenever we are looking at using past patterns, we need to make sure that we are accounting for the relevance of the data, as well as understanding why certain past patterns may repeat and the rationale behind them repeating, so that we can see how applicable these situations may be to the present time.
The first concern is that we really don’t have much of a sample size when it comes to recovering from bear markets. We also need to make sure that the timeframe that we are looking at is relevant, and can’t really read too much into ones that happened almost a century ago, such as the crash of 1929.
We can still have a look though, and while we really don’t want to put too much weight on these things, if we do see a pattern emerging during, say, the bear markets of the last 50 years, this can at least add some evidence of some sort to the idea that a second crash may be at least more of a risk.
What we’re looking for is a move downward of bear proportions, 20% or more, followed by a significant rally and then a further fall down. In 1968, 1972, 1980, and 1987, we put in our bear bottoms without any significant rallies, and then recovered without any significant falls at all, let alone one that took out the bottom.
The 2000 crash did have some back and forth going on, on the way down to the crash’s final resting place, but none involved rebounds of more than 10%. When we finally put in a major rally in excess of this, it was a real one that saw us gradually recapture the entire loss over the following 5 years.
None of this evidence points at all to the conclusion that people want to make when it comes to re-tests, and while it may seem convenient to just look at the most recent bear market, in 2008, like these folks are particularly focusing on to support their case, we’re now down to a sample of one with all of the prior data over this 50-year timeframe being contradictory, which is on shaky ground at best.
However, when we look at this most recent crash, once again, this one doesn’t fit the model either, where we did not put together a rally of more than 10% on the way down, and once we did, not only did we not re-test the lows, we moved straight up from there for 11 years, taking us right up to the coronavirus crash of 2020.
How some people could speak of a coming reversal with such confidence or any confidence at all based upon these past patterns remains a mystery. The only possibility is that they are using these lesser rallies of 5-10% that can happen on the way down with these moves and citing that as evidence that a rebound of 27%, such as we have seen with this one, is similar.
This simply is not valid, and rather than supporting their case for a re-test, this pattern evidence, for what it is worth, serves to validate the durability of this recovery, not only showing that moves of the magnitude that we are dealing with now does not re-test the bottom, it instead moves further away from it.
This is not convincing evidence by any means showing we won’t see this happen, because situations are different, but they are also similar enough that we can at least get some comfort from the fact that if we rebound by more than 10%, and perhaps especially when we move up by 25% or more, we’ve been in the clear every time this has happened over the last half century.
We Need to Look at the Current Situation Closely as Well
When we look at the process behind these pullbacks and rebounds, this makes a lot of sense, as markets tend to be cautious while the event is going on, and it is only when the worst is really past us that the big money starts to get back into the market.
This is when the value players really get back into the game, where it becomes decided that the worst is over prior to this happening, and once it does, we go from being afraid of falling prices to look at fallen prices as a real opportunity. Once we act on this opportunity in a big way, as we have over the past 2 weeks, the wheels have been set in motion, and the wheels are certainly in motion now.
While we have tied ourselves up to the point where this is going to cause a recession for a time at least, some of these prior bear markets have been accompanied by recessions as well, so we can’t use that to differentiate this one. That doesn’t seem to stop people though.
Nitin Saksena, an analyst with Bank of America, for instance, believes that “it would be unprecedented if the S&P failed to re-test or even fall below its March 23 low, given the size of the recent drawdown (-34%) and assuming a recession ensues.” It actually would be unprecedented if we did re-test these lows, at least if we actually look at the evidence.
If we want to be technical analysts, like some of these people seem to wish to be, we have to make sure that we are practicing the craft in a manner that at least smacks of some validity. It’s not that the practice of technical analysis by trained analysts doesn’t end up making serious errors and end up being off base, but this mistake isn’t just glaring, they are basing their conclusions on evidence that opposes what they are seeking to show and don’t even realize it.
While we do need to at least have a look at possible similarities between moves like this, we also need to focus on differences, and this current situation is certainly unique. What stands out so much about this one is that we are left to speculate so much on both the severity of the economic damage so far as well as the extent of the damage to come as we seek to get our nerve back up to return to normal life again.
Nordea strategist Sebastien Galey points out that while there has been “a genuine shift from crisis to recovery, we are still very much in troubled waters waiting for the second wave of the crisis to sink in.” There isn’t much doubt that we are still in troubled waters, but this is not enough for a re-test, as the waters need to become even more troubled than they were back then, the very troubled waters that had us sinking by this 34%.
There is nothing that scares markets like the combination of uncertainty and doom. Those of us who have looked at this situation carefully ended up defining the risk pretty well, but the majority of the world at the time of the big fall had been duped into this being the second coming of the Spanish flu, or perhaps even worse than that, and as the numbers piled up more and more, stocks moved downward in tandem for quite a while, with terror carrying the day.
We need to separate the risks here, the health one and the economic one, and it was clearly the health risk that was so undefined in the minds of the market back then that caused this big of a drop in stock prices. Now that we are starting to catch on that this pandemic is much more modest than we were told by the media and health officials, this in itself served to quell the bigger part of what was scaring the markets back then.
Once we started locking things down, it was no secret to anyone that this would impact the economy while this persisted and would especially impact earnings. Of the two risks, the economic one was easier to define, even though neither were really that easy to define as we did not see this outbreak at any time grow to levels where the millions of deaths that were feared from this were ever realistic.
The market eventually woke up to this though, and the fear ended up diminishing to the point where people saw the bottom of March 23 as a genuine-looking one, and there are some good reasons for this being a real turning point. The light at the end of the tunnel may have been far off, but we could at least see it in our field of vision, which had us then turning to the value that these beaten-down prices represented.
No one knows for sure what will happen once we do define the economic risk more clearly, and these things can produce some real sell-offs. No one expects that the road back will remain as smoothly paved as the last 2 weeks have been, even though history teaches us that when the value money is back in the game, we don’t really see pullbacks of any real duration or significance, but to fall even lower is going to take some real panic indeed.
We need to keep perspective here, and as bad as things have been during these times, from a fundamental perspective, the 34% we gave up doesn’t even come close to making sense. To think that the long-term value of stocks has been hurt by a full third by this is a crazy idea in fact, and we know it is, and this is why once the thickest of the smoke cleared with this issue, the extent of the overselling that we all knew was massively overdone became seen as the significant opportunity that it was and still is for the most part.
It’s Hard to Imagine a Second Wave of Panic Bigger than the Original One
Whatever the numbers end up being, they will surely pale in comparison to the sheer panic that guided us downward during its peak. We were told that the sky was falling, and to a great extent, we believed it. The sky is still there, and the dark clouds are at least starting to blow over, so while there may still be storms, how these new storms could possibly be bigger than the one we thought was coming is a real mystery.
While many may be pointing to the potential of a very extended lockdown, which would certainly have the potential to do damage to the economy and stocks well beyond anything we have ever seen in history, making the Great Depression looking like a street party, this just isn’t realistic, and we could not maintain such a thing even if we wanted to.
Some of these so-called experts are now telling us that while we avoided the doom that they dreamed that this outbreak would become, the doom is still at our doors and we need to keep things closed down for a year or more. The evidence is once again not on their side though, but given that reality has not played a role in their beliefs thus far, we should not be surprised that this is still not the case.
Their extremely exaggerated projections about both the impact of this virus and the impact of not locking us down with stay at home orders just have not manifested anywhere near close to what they imagine. For the sake of knowledge, not everyone locked themselves down over this, and we do have plenty of evidence that shows that the sky has not fallen in these places where life continues on normally.
It is not that stay at home orders don’t help, and they at least do in theory, even though comparing areas that have and have not implemented these extreme measures have delivered mixed results at best, and certainly have not caused the sky to fall or anything close. This is all about whether the difference is justified, and whether we like it or not, this does all come down to economic calculations, because we are always going to be able to prevent a lot of deaths by keeping people at home like this, but it has to be worth it.
It is one thing to think that it might be when people are terrified by thinking that we are facing an outbreak and death toll of epic proportions, comparing it to the worst we have ever seen, such as the Spanish flu, and if there was any merit to this, locking things down might even be the wiser choice.
However, as we realize that this is a lot more like the regular flu than the Spanish one, and especially after even this more modest outbreak than most thought it would become significantly dies off, wanting to keep the economy locked down goes from extreme to simply insanity.
With people chomping at the bit to get back to their lives, we are gradually getting back our sanity, even though the process may be slow. There is still lots of talk about our needing a vaccine to get back to normal, but given that the updated models we now have are seeing this all being over soon, at least this leg of it, this is another big head shaker. Heads can only shake for so long.
As we regain our faculties, we will hopefully come to a better understanding of what the threshold of risk actually needs to be in order to bash our economy and way of life this much, and whether or not we see our approach to this as being excessive, there is no question that continuing to choke ourselves when the threat has ended would be well beyond even minimal standards of sensibility.
If we do end up getting another wave of this as some believe, even though there is no good reason to think this based upon our previous experiences with novel coronaviruses, we do not want to be using such extreme measures just to be proactive, committing economic suicide in fact, based upon wild speculation that even if true would surely represent a smaller risk than the initial outbreak.
This leaves us with looking at the potential impact of the economic numbers, but even though there may be a little shock and awe, none of this is any secret and we’ve already priced in a lot of this. To think that the part that we missed will be enough to not only compete with the original sell-off when the sky appeared to be falling is possible, as anything is possible, but remains quite improbable and not something we should be basing investment decisions on.
If we ever do see such a thing though, we will know it, and it won’t be that we will wake up one day and look at the market and see it give back this 27% and more. We always need to keep an eye on things and continue to interpret events as they unfold, but this re-test scenario simply is not unfolding and remains quite unlikely, in spite of what various analysts may believe.
Editor, MarketReview.com
Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.
Contact Monica: monica@marketreview.com
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