Marc Cuniberti: Market correction theory
As the COVID-19 shutdown continues worldwide, the damage to global economies has yet to be realized.
How much damage the shutdown does to each country’s economies can only be guessed. One of the few things we know here in the U.S. is that unemployment is skyrocketing.
The many unknowns include but are not limited to how many mortgage defaults will be seen, how many small businesses will be reduced in size or disappear altogether, the number of corporate bankruptcies we will see, how many people will be driven into the ranks of the homeless and how long will the overall damage to the economy will last.
Judging by the performance of the stock markets’ nearly 25% rise in recent weeks, a case could be made the recovery is already starting. But the market’s surprising upward performance in light of such dire economic expectations begs many questions.
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Does the recent meteoric and historic rise in stock prices make sense and is the rally any indication of what will happen in the overall economy? Why is the market rising so fast in the face of possibly the worst economic disaster in modern times? Will the market keep rising and if so, will it continue at the breakneck speed we have just witnessed?
Prognostications as to what will happen run the gamut. But if certain market theories hold any weight, and they do for many experts, the rebound in the stock market could have been predicted. Additionally, these analytic methodologies may also give us an indication of where stock prices might go next.
After a historic run up in stock prices, the common belief is the longer a market runs, the closer it gets to its correction date and the more severe that correction will be. One often quoted term is that a parabolic and continued rise in stocks is an ever inflating “balloon looking for a pin.”
The “pin” is an event that causes its sudden bursting and in stocks that means a horrific crash.
One could argue that a healthy market can withstand negative events with a measured retreat instead of a cataclysmic crash. Of course COVID-19 is no ordinary event nor is the shutdown it has caused.
Indeed, the world has never witnessed a complete global shutdown. But in a market that nearly added 38% in 40 months (Dow 18,332 Nov. 8, 2016 to Dow 29,563 Feb. 12, 2020), many analysts expected a major correction was only a matter time.
With the Dow crashing to about 18,591 on March 23, 2020, about 38% was shaved off the Dow in a little more than a month. This historic crash set the record for the fastest Dow correction from an all-time high to a bear market determination (down 20%) and then fell even farther.
From the low on March 23, the Dow gained more than 6500 points or 23%. Hauntingly this gain took a similar amount of time as the crash. A little over a month.
Now with the Dow appearing to possibly stall out, the question investors are asking is where do we go from here. Although no one can forecast market direction at any time, many theories abound as to what has happened in the past and what might happen in the future.
A popular belief is a retest of recent lows may be in the cards. Some argue the amount of stimulus the government has added puts to rest another severe correction. Others believe at least a partial retest is not only possible but probable.
If the market continues up from here it will be described as a V-shaped recovery. The V portion of the term describes a quick fall and quick rebound with no retest of the previous recent lows.
Others prescribe a U-shaped recovery is more likely. U-shaped recovery points to a much slower and gradual return to upward price movement with any number of retests being the likely pattern of recovery.
In my opinion it is highly unlikely the market will continue the rally we just witnessed. Although market movements are impossible to forecast without exception, there may too much economic damage for a sustained and uninterrupted new high to form a V-shape type of recovery. More likely will be a number of retests to form more of a U-shape over a longer period of time.
Indeed, the disconnect between the market and what the consumer is experiencing is baffling to say the least. Although it is said stock markets look six months or more ahead, the virus is not eliminated, the shut downs have not concluded and the consumer is reeling.
To imagine things will be resembling anything near normal in short order is inconceivable, at least to this analyst.
Marc Cuniberti is an investment advisor representative through Cambridge Investor Research Advisors Inc. a registered investment advisor. Marc can be contacted at SMC Wealth Management, 164 Maple St. #1, Auburn, 530-559-1214 SMC and Cambridge are not affiliated. His website is moneymanagementradio.com.
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