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Mar 17, 2020

Recessions and Bear Markets: Not Created Equal

In this article, we elaborate on the exogenous shock of COVID-19, how this has been the fastest bear market correction we’ve entered, and why we believe we’ll encounter a “V-shaped” recovery.

Ric provides leadership to the research team, oversees all mandates at CWB McLean & Partners, and is the portfolio manager for the firm’s International, Fixed Income and asset allocation strategies.

There are significant differences between traditional recessions, those brought about by large imbalances in the economy (like the tech bubble in 2000 and housing bubble in 2008) and those brought about by an exogenous shock coming out of the blue. The difference lies in its effect on aggregate demand. The drop in demand caused by an exogenous shock is not structural and can be managed by government support through expanded fiscal measures and central banks lowering interest rates, as well other non-traditional monetary policies like quantitative easing and asset purchases. These actions cannot stop the recession, but they allow for a much faster recovery once the exogenous shock fades. This is what we consider a ”V-shaped” recovery.

The average length of a recession is 13 months (Figure 1). An influenza pandemic in 1918-1919 (a major exogenous shock) which was global in scope, infected 33% of the world’s population and killed 50 million people lasted only 7 months.

Figure 1: The 1918-1919 Recession Lasted 7 Months

The 1918-1919 Recession Lasted 7 Months  

Source: Deutsche Bank Research

Downturns are inevitable, and are also temporary. The key lessons learned from crises are that there is “an action/reaction in action”. What do we mean by this?

With the exogenous shock of COVID-19, the slowdown and disruption caused by the virus (the ‘action’) is being met with massive fiscal and monetary policy stimulus (the ‘reaction’). These policies provide governments, consumers and businesses incentives to spend. We believe this spending will permeate through the global economy quicker than a prolonged or "U-shaped" recovery would imply. All policies being implemented (and there are far too many to get into detail here) are designed to ultimately stoke demand, not destroy it. This is not the case in more traditional economic recessions, where there is excess demand stoking inflation and central banks are raising interest rates to cool the economy. Once COVID-19 stabilizes, we believe there will be substantial pent-up demand.

Fastest Bear Market On Record

In previous crises like the Global Financial Crisis (GFC), which was the most severe crisis since the Great Depression, stocks fell 57%. They did so starting in 2008 through 2009. One of the reasons this correction feels so jarring is because it has happened over a record time period (Figure 2).

Figure 2: 15 days – Fastest bear market correction in the S&P 500 on record

15 days – fastest bear market correction in the S&P 500 on record   

 Source: Deutsche Bank Research

Unfortunately, no investor, big or small, has any better insight in trying to figure out how this virus will play out. It is unquantifiable because there are far too many variables and ranges of outcomes. As such, many investors rely and make investment decisions based on the hour-by-hour and day-to-day headlines. This may prove to be dangerous because emotions tend to get in the way of logic, and fear gets in the way of discipline.

The biggest lesson learned during the GFC was that great investors differentiated themselves from the rest as they were able to stick to their discipline, and not get scared out of the markets. These great investors were not nervous about bear market corrections, they welcomed them as an opportunity to buy great, quality companies at discounted prices. While many of those investors have different investment styles and different investment philosophies, they all have one thing in common: they stick to their investment process and are disciplined in execution, especially in the face of the stock market chaos. We too will steadfastly and obsessively stay disciplined to our own investment process and philosophy on your behalf, irrespective of the noise that the hour-by-hour and day-to-day headlines bring.

Conclusion: The only chart that matters

Figure 3 shows various curves of COVID-19 cases around the world. China has managed to flatten the curve and life, by all accounts, is returning to normal. In fact, Apple announced that it was shutting all its stores globally, except those in China, which will now remain open.

Figure 3: Cumulative confirmed COVID-19 cases

various curves of the COVID-19 cases around the world

Source: Deutsche Bank Research

We still do not know how bad the short-term impact of the virus will be. What this boils down to is not a financial situation, but a medical one. It’s not if COVID-19 can be controlled, but when. The uncertainty over when the rest of the world’s lines will begin to flatten is driving unprecedented volatility in global markets. The catalyst to stabilizing the markets will be when COVID-19 shows signs of receding in the rest of the major economies.

As a final thought, we draw an emphasis to the word ‘when’. Time horizon is one the most important determinates of an investment strategy. We cannot tell you with any confidence what the market will do tomorrow or next week or next month. However, our confidence and probability of success grows with time. We say this because while history never repeats, it does rhyme. The actions taken and lessons learned from previous crises can and should be applied here. As an investor, if you have a multi-year time horizon, it’s during times like these where the greatest opportunities exist.