Between February 20 and March 20 this year the FTSE/JSE All Share Index fell 34%. This was one of the sharpest drops in the market’s history.
Since then, however, it has delivered an impressive recovery. It has gained close to 30% and is down just 14% for the year to date.
This bounce has made some investors wonder whether the worst is now over. Was the low point in March the bottom of this bear market?
Name this bear
When trying to answer that question, it is worth asking what type of bear market this is.
“The distinction is interesting because clearly you get arbitrary market movements where the market does something crazy and you can’t understand why it does it,” says Rob Spanjaard, chief investment officer at Rezco Asset Management. “This is when there is no underlying economic problem – a correction without a recession. These can end fairly quickly.”
This was the case in 1987 when the market fell about 30% without an economic cause. The recovery was, however, quick.
“Bear markets with recessions, on the other hand, tend to be more drawn out because of fundamental economic problems that need to work through the system,” says Spanjaard. “The most recent examples come from 2000 with the dotcom crash that was followed almost immediately by 9/11, and the global financial crisis of 2008.”
It takes time
While many might remember the recovery from this most recent bear market as being swift, in reality, it was drawn out.
“After the great financial crisis, it took you five years to get your money back on the US market,” Spanjaard points out. “It was about 18 months of falling and two and a half years of recovery to get back to where you were.”
This, Spanjaard believes, is the type of scenario the current market is more likely to face.
“If you take the most recent numbers from the IMF [International Monetary Fund], this is a recession, and a big one,” he says. “It could be the worst since the Great Depression, probably worse than the global financial crisis.”
This makes it unlikely, in his view, that the market has already hit the bottom. A lot of information still has to be digested. The recent gains are more likely a bear market rally.
The rise and fall
“A market is always dynamic,” Spanjaard points out. “It gets oversold until there is an exhaustion of bad news. If you then see the kind of stimulus that we have, many people think that this is the time to buy and ignore the bad economic numbers you know are coming. That drives the rally.”
However, a major disruption to the world economy is still taking place and will be for some time.
“Bear markets aren’t normally over in three weeks,” says Spanjaard. “If it’s a flash crash and the market is being irrational, like in 1987, that kind of market can recover very quickly because there’s no underlying economic problem. But we think investors have forgotten what a bear market looks like.
“In this case, all the economic bad news still has to come through,” he adds. “We are not at the depth of negativity.”
The effects of corporate earnings still have to be seen, and these could be severe. Profits for some companies could fall as much as 50%.
“The coronavirus might also be harder than you think to come out of,” Spanjaard says. “There might be treatments, but we might also have to wait for a vaccine. There is not a simple answer to the problem.”
There is therefore still a lot of uncertainty about the length and extent of its impact.
“Will there still be social distancing even after governments lift lockdowns, for example?” Spanjaard notes. “It could take a while for people to get their confidence back, to spend money, to travel, to eat out. Some people might, but as an aggregate, the animal spirits of the economy take a while to come back.”
This will reflect in companies reporting depressing profits for some time. The market has yet to see this.
“We always tend to have rallies and falls as the market discounts the bad news appropriately,” Spanjaard points out. “What we mean by ‘appropriately’ is interesting because eventually, markets are efficient. Eventually, the economic reality is in the price, but it takes a period of time.”
A second chance
Investors should, therefore, be cautious about being too complacent after the recent gains. For active asset allocators, Spanjaard believes this rally is offering an opportunity to derisk portfolios.
“A few weeks ago, we were saying that the market was too cheap to sell, but not cheap enough to buy,” he says. “Now you can’t say it’s too cheap to sell. You have an opportunity to lighten your equity exposure at these levels.”
“The market is asking us for a second time if we really want to be invested,” he adds.
“Asset managers are paid to make asset allocation calls, and we think they should own that responsibility. There’s still too much economic risk, and too much forecast risk in earnings projections over the next three years,” Spanjaard says. “There will be great opportunities, but they aren’t there now.”
Brought to you by Rezco Asset Management.