Monday, April 13, 2020

Have We Put In A Bottom?

To a person, the smartest traders I know acknowledge the uncertainty of the current market situation.  That is because the fate of economies and the fate of markets are so intertwined with the fate of the coronavirus outbreak and the ultimate policy responses we make going forward.  Tyler Cowen notes the large confidence bands for forecasts in epidemiology due to limited data and the simple fact that the virus truly is novel.  His base case, like that of many informed writers I follow, is that we could have rolling periods of social distancing and COVID flare ups until a vaccine is developed, tested, manufactured, and delivered.  The unevenness of social distancing efforts so far suggest different disease curves for different locales.

We have seen a record rally in recent days, with over 90% of stocks closing on Thursday above their 5, 10, and 20-day moving averages.  (Data from Index Indicators). That not only means the market is strong, but that institutions are buying up pretty much everything.  That is not a response that suggests uncertainty!

I spent a chunk of the weekend studying what happens in the market when we get very broad rallies following very broad selloffs.  Please check out the recent Forbes article for all the details.  One of my major conclusions from this exploration of market history was that such volatile downs and ups lead to better trading environments than investment environments.  Even in recent times (since 2006), the large, broad bounces (in 2011 and in 2009) were ultimately followed by lower price lows.  Further back in history, in the bear markets of 1972-1974 and the 1930s, the ultimate price lows were quite a bit lower than the points of initial broad buying.  During such periods, volatility was more persistent than price direction.

So have we put in a bottom?  The great majority of instances of broad bounces since 2006 were higher one year later, often with meaningful swings along the way.  In the previous, larger bear markets, assuming that the first broad bounce meant we had put in a bottom would have been hazardous to one's wealth.  The bottom line is that we don't know the ultimate course of the virus, and we don't know the effectiveness of our responses to the viral situation going forward.  What we can safely forecast is that there will be waves of optimism and pessimism along the way, with extremes of buying and selling, that will create meaningful trading opportunity.  As Mike Bellafiore and I noted in our recent presentation for MoneyShow, this can be a historic period of opportunity for rational traders able to flexibly adjust their forecasts as data emerge and adapt their trading accordingly.

Further Reading