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When Will Stock Market Recover?

If you didn’t know anything about the coronavirus and remained clueless about the economic devastation, you might look at a chart of the S&P 500 (NYSEARCA:SPY)and think that a severe market correction was rebounding and equities would soon reclaim the previous high-water mark. Reality, however, isn’t quite that simple.

 

By James Picerno

To be sure, the S&P 500 continues to rebound after suffering a dramatic collapse in previous weeks. Following the sharp 33.9% maximum drawdown (Mar. 23), the market has rallied nearly 29% (as of Apr. 27). But there’s still a long way to go before the S&P reaches its previous apex, set on Feb. 19, which marked a record high.

Will the market fully recover? The answer, of course, is almost certainly: Yes. The only mystery: When? Maybe it’s next month, maybe it’s in ten years. The critical factor, to cite the obvious: the evolution and details of the coronavirus crisis that’s roiling the world.

A thousand questions complicate the path of the recovery, for the market and the economy. When will the Covid-19 fallout peak? How quickly will the economy bounce back? Will it be a “V”, “U” or “W” recovery? Will there be a second and third wave of infections? And on and on.

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The answers will arrive… one day at a time. While we’re waiting, what does history tell us with respect to market drawdowns and recoveries? The results are somewhat blurry, but as an academic exercise let’s review some of the relevant numbers. As one piece of the analysis, the chart below compares the length of recoveries (trading days) following all 574 drawdowns for the S&P 500 since 1950 vs. the maximum peak-to-trough declines.

The first observation: most of the drawdowns were trivial (no deeper than -10%). With just a handful of deeper drawdowns in the data set, drawing high-confidence insight from the results is challenging, to put it mildly.

Modeling the trend for drawdown and recovery periods with a linear fit shows the obvious relationship: the deeper the drawdown, the longer the recovery. A loess fit offers a bit more accuracy for modeling the linkage. But with so few data points for the deepest drawdowns, caution is required.

Throwing caution to the wind allows us to notice that the maximum drawdown in this year’s correction (red line in chart above) implies that something on the order of 500 days is implied for anticipating when the S&P will return to its previous high. Since the data reflects trading days, the 500 mark puts us at a new high at roughly the spring of 2022.

By contrast, at the rate of the market’s recovery so far, the implied rebound to the old high will take another month or so. Really?

Unfortunately, Mr. Market is as cagey as ever. Are we in a bear market rally or is this the middle of the fastest recovery on record for such a steep drawdown?

The old gentleman isn’t saying, although he’s probably laughing to himself, knowing that most of us, whatever our prediction, will be likely be wrong… again.