Stock markets during a pandemic: where is the bottom and what should investors do?

Stock markets during a pandemic: where is the bottom and what should investors do?

The impact of the coronavirus on the world economy has been compared to the Great Depression and the aftermath of World War II. Accurate calculations and detailed analysis of losses will take months. Stock markets have a life of their own. Two opposite scenarios are probable here: the growth of the last weeks may continue or another deep correction may occur. Trying to guess the bottom for indexes is useless.

Growth of indices amid recession

Countries around the world are just beginning to calculate the real losses from the coronavirus epidemic. Most national economies will experience severe recession this year. Globally, losses will amount to about 3%. Unemployment is on the rise, and oil prices are at a 20-year low.

Against this background, the charts of the stock markets look amazing. For more than a month, the main indices have been showing growth. Macroeconomic indicators are definitely not getting better, only worse. What is going on?

The S&P 500 index, having shown the most rapid fall in history at the end of March – by 36% – by the 20th of April, regained 26%. Stock indexes in the United States and around the world were hitting unpleasant records.
The specificity of stock markets is that they are not a mirror image of the state of the economy. As we explained in the last article , the peaks of the indices usually occur just before the start of the recession, and the reversal can happen well in advance, before the economy has even begun to recover. Investors’ expectations are incorporated into the share price, quotes are very sensitive to the news background.

The flow of negative information related to COVID-19 has become habitual during the quarantine. People are trying to get something out of him that at least partially resembles a positive and, probably, overestimate the importance of positive factors.

More and more often one can hear “expert” opinions that on March 24, when the maximum fall of the stock markets happened, the bottom was reached. Below it seems like there is nowhere to fall.
Analysts at Morgan Stanley and Goldman Sachs have released reports that predicted the rapid growth of the global economy for the second half of 2020. But, if we remain realistic, from the current levels, two opposite scenarios are possible. It is too early to arrange fireworks on the occasion of the return to a peaceful life.

How business was saved

How business was saved

In February and March, the markets dived amid sheer uncertainty. Nobody knew how long the quarantine would last, how deeply its impact on national economies would be, whether the governments of developed countries would help businesses and to what extent.

A lot of interesting things have been observed in the last month. The governments of many countries, whose economies have been under serious pressure from the coronavirus, have taken massive and coordinated measures to support the population and business. These include:

  • one-time non-refundable payments to citizens, small and medium-sized businesses;
  • regular supplements to social benefits during the epidemic;
  • compensation of employees’ wages to enterprises;
  • fiscal measures to ease the credit burden, lower rates and provide soft loans.
The US government has already spent over $ 2 trillion to support small businesses. About 1.6 million companies received funds from the special fund. By the end of April, the money in the fund ran out, it was decided to send another 480 billion. Stock markets appreciated the efforts of the authorities to support businesses and ordinary citizens. The dynamics of the pandemic itself has slightly improved in the countries that faced it back in February. In percentage terms, the spread of the virus is slowing down. There is no exponential increase when the number of cases increased like a snowball.
Many countries have already announced the gradual lifting of restrictions. They talk about the opening of individual cities and states in the United States, public locations in Europe. An idea appeared to do immunity tests, to identify those who have already been ill, in order to understand who can be released into the economy without limit, removed from isolation. There was more certainty and stock markets began to rebound.

Scenario one: gradual recovery, growth of quotations

Markets are always trading on expectations of what lies ahead. So far, one fact remains clear: all industries and virtually all listed companies will suffer. Nobody can say how strong, what the fall will be in the end, in what numbers the negative effect will be expressed. There is no exact data, but the markets have already grown. Moreover, they have grown strongly, which creates a certain dissonance.

Two factors point to a positive scenario:

  1. Investors are already looking for long-term improvement in the situation.
  2. Central banks keep interest rates low.
At the end of April, the company started reporting season for the first quarter. According to some forecasts , US corporations in the S&P 500 index could lose 16% of profits in the first three months, which will be the largest fall since the second quarter of 2009. If the market leaders say that the difficulties are temporary, the state support was adequate, the markets are likely to continue to grow. In this scenario, 2020 on the stock markets may close in positive territory.
In developed countries, interest rates are very low, they always have an impact with a time margin and make the stock market very attractive for investments in the future.
In the US, the Fed has set the rate at 0.25 points, in Europe, rates are completely negative. Even the Central Bank of Russia lowered its key rate to 5.5% for the first time since 2014; few expected such a soft policy from it. This is very good news for the stock market. We may well see the S&P 500 in the next year and a half at 4,000 points. Investors are at a low start, everyone wants to buy while the stock is relatively low.

Scenario two: new fall in equity markets

The second, less likely, but quite realistic, scenario is that stock markets have not yet bottomed out. Again, we are missing something important, some factor can play a negative role in the development of the whole story with COVID.
Can the bottom of the stock markets, about which there has been so much talk lately, can be expressed in concrete figures and predicted? For those who advocate fundamental analysis, most likely not. Technical analysis, which takes into account only charts, finds out what patterns trading on the market for a certain period looks like (head and shoulders, flags, etc.), believes that it is possible.

Adherents of technical analysis believe that a bubble has formed in the stock market and a reversal pattern has emerged. According to some forecasts, the S&P 500 should fall below the level of 2200-2500 and only after that the real recovery will begin.

The problem is that the behavior of investors during periods of strong declines or increases in the markets is largely irrational. Formulas cannot predict the future. No analytical model and no algorithm could foresee a one-time drop in WTI oil futures to minus $ 40.

A small bubble has indeed formed in the market. In March, during the strongest fall, few investors bought more. In the last few weeks, stocks have started to carry money, strengthening the uptrend. The industry’s markets are larger than they should have been based on actual performance. This is a standard situation in the markets: it does not happen that it grows where it should and falls where it should. All the time the pendulum misses. Therefore, a correction is possible.

What should investors do?

For long-term investors, regardless of the curve of stock market indices, the answer will always be the same: do not try to catch the moment for a successful entry. Theoretically, he is, but it is extremely difficult to guess with him. The optimal strategy for a long-term investor is to gradually add funds to your investment portfolio. Even if you invest just before the fall, on the long horizon, the market will still bring you a profit. You can enter the market and not be afraid by choosing reliable companies.
From the point of view of a speculative investor, there is an intermediate phase now. According to the textbook, it was necessary to buy shares a month ago, when the markets found a local bottom. Given that stock markets have been rallying for almost a month, well outstripping the reality, such an opportunity is likely to arise.
There is at least one big positive thing about this whole coronavirus story. The mechanism of global quarantine has been worked out on a global scale. A set of economic and social measures has been developed that are most effective in such a situation.

It is fashionable now to say that the world will never be the same. In fact, humanity has experienced dozens of more terrible mass epidemics in its history. The last plague epidemic happened in the middle of the 19th century. Back in the 20th century, people were mowed down by local cholera epidemics, when, without medical intervention, the mortality rate reached 50%. We are partly lucky that coordinated global quarantine measures have been worked out on a relatively weak pathogen. Next time, perhaps, states will react more quickly to the threat of mass infection.