Market Peaks and Valleys Amid the COVID-19 Crisis

  • COVID-19 peak is key, but hard to pin down
  • Investors are looking for the bottom as stocks swing
  • How to identify the bottom and the start of the recovery

U.S. markets are trading sharply lower Friday morning, halting three straight days of gains for the major indexes. The U.S. now has the most cases of the coronavirus on the planet, and the threat to major cities and their hospital systems is becoming very real. Meanwhile, the disconnect between the financial markets and the realities of the global health crisis and the economic slowdown is growing wider by the day.

While U.S. markets have rallied 23% off their lows in the past three sessions, which is technically a bull market, these kinds of moves are not uncharacteristic of what we have seen in past bear markets. In 1929, the S&P 500 plunged 34% in a month. In the next two days, stocks rallied 18%, and then plunged another 26% over the next 13 days. We are not saying that will happen, but don’t let the recent three-day string of gains fool you. It's a classic bear trap.

We are just getting into the teeth of it.

How to Identify a Bear Trap

In the midst of a volatile bear market, stocks often spike 10-20% in the course of a few days, but historically retreat to lower lows until a true bottom is formed.

We've all heard of efforts to "flatten the curve" by now. Authorities and health experts have been calling for social distancing and lockdowns so that COVID-19 cases don't cause health care systems to become overburdened. Today we'll look at two other terms trending in the news and what they mean for stock markets around the world. 

Another word you should be familiar with in the present context is "peak." It's when the outbreak will reach its highest point and we'll see new infections reported per day start to drop. Scientists have been tracking the disease and making predictions based on different models. New York Governor Andrew Cuomo calling for the Federal Defense Production Act to be enforced said the height of the pandemic is just two to three weeks away for the city.

It's hard to predict a peak because it changes based on how society reacts collectively. Wuhan, China, for example, hit its peak a few weeks after it imposed dramatic social distancing methods in late January. However, a new study funded by the Bill & Melinda Gates Foundation has also suggested there could be a secondary peak in Wuhan if restrictions on activities are lifted before April.

And, the bottom. The bottom is the lowest price for a stock or index in a particular timeframe and signifies a turning point. The chart below shows google searches for "stock market bottom" in the U.S. over the last year. As you can see, investors are desperately seeking signs that we've touched the bottom and ready to swim to the surface.

Google Trends stock market bottom
Source: Google Trends.

"I don’t see any meaningful bottom for stocks until we get some wins against the virus. Italy has to see new infections peak," wrote Joshua Brown, CEO of Ritholtz Wealth Management, on March 25. "That will be a huge upside catalyst for the market when it happens. New York will be even bigger. But neither of these things appears to be imminent. Everything reads as though the situation is getting worse, and faster."

Hedge fund manager Paul Tudor Jones told CNBC yesterday, "I do think the stock market’s going to find a bottom once we get a peak in the epidemic curve, [there’s] not a doubt in my mind the stock market will rally. My guess is we’ll be higher three or four months from now, five months from now, than lower than where we are right now."

Credit Suisse listed a peak in infection rates as one of the requirements for a bottom in global stocks. The other two were clear-cut fiscal easing in the U.S. and a trough in global purchasing managers indexes.

In the near-term, Goldman Sachs expects the S&P 500 will fall towards a low of 2000 (it's at 2,630.07 currently) and analysts said the difference between a "V" and "U" shaped recovery in the stock market will depend on three developments: 

  1. Whether the virus can be contained quickly, an answer difficult even for epidemiologists;
  2. Whether companies, both large and small, have access to enough capital and liquidity to last the 90 to 180 days most investors expect (hope) will encompass the worst part of the crisis; 
  3. Whether fiscal stimulus will act quickly enough to stabilize the economic and earnings outlooks. 

Questions 2 and 3 are being addressed by central banks and policy makers. Question 1 represents the ultimate challenge and it is something we can all help solve by doing the right thing.

"One possibility is that business activity cannot normalize by late 2020 because the viral spread is worse than expected or has a hiatus and recurs in the fall. In addition, if short-term shutdowns lead to business defaults, closures, and permanent layoffs, the damage to corporate earnings growth could persist well after the virus is contained," said the Goldman note published March 20.

Jobless claims hit a record 3.3 million in the U.S. last week. But there is hope, according to LPL Research. Analysts wrote that since the U.S. economy was not in a recession prior to the crisis, workers are not being let go because of some structural fault in the economy or a financial crisis. We may not see the extended hiring delay that has typically followed recessions when the slowdown ends.

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