A typical pattern for a correction looks a little like this. The first phase is panic selling, indiscriminate selling, regardless of the company. High risk, high uncertainty.
The second phase is the snap-back – a sharp recovery where the market realises that its oversold. It does not really know by how much – it’s still working out what the real value is. Medium/high risk, high uncertainty.
Phase three is a resetting of company forecast earnings and expectations of the economy. We are here now. Earning season begins in August – those who upgrade earnings during this environment will be rewarded handsomely. Those who give guidance will be rewarded. Medium risk, medium uncertainty. Stock picking and trading is critical as there are still many risks.
Afterwards phase four is the resetting of expectations and the outlook. The market and the world economy starts operating more normally. Low risk as certainty is higher.
The R word
Normally in a recession, demand gradually gets weaker and weaker until we reach a low point, and the markets gradually get weaker as the data deteriorates. In the CFC (Coronavirus Financial Crisis) all the weakness has been immediate. Quite unusually, we reached the worst incredibly early. From here the rate of improvement should accelerate.
At times where confidence in the recovery wanes it will lead to markets taking a pause – this is where the views of market participants are challenged. The question becomes will corporate earnings justify the share market level at that time? Stimulus and increased confidence will be the key driver to economic and market recovery.
The share market rally since March is still the most detested market rally of all time, as most institutional investors have missed it. This means that whilst the initial recovery may have been fuelled by new investors, the traditional investors still need to make investments – leading to broader support to the continued market recovery.
These periods offer opportunities. It will not be up all the time, it never is. Overall we expect a solid recovery to 6800 leading into February 2021.