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Three Phases of Recovery

My thoughts evolve daily in respect to the pandemic crisis in which we are all embraced. After a few days on my tractor in the back 40 acres, I would like to reflect on some of those tractor-seat thoughts.

In my last memo, I wrote about three phases of recovery. I am confident that phase one, being the recovery due to extreme overselling, is complete. Phase two is starting and will focus on medical news and the reopening of the economy based on the concept of levelling.

We could retrench back into phase one if current news about the pandemic turns back into fear, which would be a second wave of the virus. Phase three, when corporate earnings and balance sheets are fundamentally normalized, will be some time away.

The performance numbers for the month of April look great, with the Dow gaining 11.1% (biggest monthly gain since 1987), the S&P 500 up 12.7%, and the Nasdaq posted its best monthly gain since 2000 at 15.5%. The Canadian index was equally as strong (even with oil prices collapsing) returning 13.4%.1

While these numbers are encouraging and will look a lot better on our April statements over our March statements, we need to reserve ourselves somewhat as we still have to get through phases two and three, and volatility shall remain.

Market Correction or Market Reaction?

Three Phases of Recovery

In principle, “correction” and “reaction” may appear to be the same. From my tractor seat, however, the cause and effect is very different. We have had several market corrections in history, the 2007–2008 financial crisis, the dot-com bubble, the oil crisis, to name a few. In the backdrop to these events, the state of the economy was the basis for cause and effect. The above situations I will categorize as market corrections.

Our current situation for cause and effect is non-economically driven. While it has certainly led to economic effects, it is the cause I want to focus on, as a medically driven cause.

I have done extensive reading and had discussions with numerous industry advocates over the past two months and concluded that the range of predictive outcomes is extreme. The market strategists are looking to past market corrections to academically support a theory that the current markets shall retest the lows established back on March 23.

For many investment professionals, a retest of the market bottom is a foregone conclusion. In fact, a poll of financial advisors conducted in early April revealed that 81% expected the US equity market to retest the March 23 low.2

These poll results do not surprise me, as academic modelling shows that a market bottom is typically three phases. We have seen phase one, with the fast decline and volatility and investor sentiment bottoming out. Phase Two is a recovery rally, which is obviously occurring given our April performance. Phase Three is what calls for the retesting of the previous low. The debate is whether or not this will occur, as past experiences suggest and the poll supports.

Changing gears (like in the tractor), if we idealize this as a non-economically driven cause, then academic modelling may not be the correct thesis. The day before the pandemic market reaction, markets for the most part were healthy, corporate earnings and balance sheets remained strong, employment figures were supportive, global trade was occurring and we were all happy with our portfolios. This was not the financial landscape when past market corrections occurred.

We get a market reaction to the global pandemic news amid a strong economy. The reaction elevates through the markets by the risk model trading and exchange-traded funds (ETFs) liquidity requirements that I have written about in previous memos. If we can conclude these events to be a medical cause, then our academic theories of retesting the low may not be the best current basis for predictive modelling.

Time will tell if I am creating another financial term called “market reaction.” I will leave my tractor-seat thoughts for you to select which viewpoint you tend toward, correction or reaction. Time will ultimately measure the theory of retesting the lows in a typical market correction cycle, or if this was a market reaction event, and lows will not be retested unless a second negative cause is established to drive markets lower. Without this second catalyst, my belief is the lows are established. This catalyst can range from a second wave to improper or untimely decisions from policy-makers. Both of which are possible.

Current Views on a Depression

There is a significant amount of media hype claiming that a depression will occur and I’ve received a few concerned calls from clients as a result. I think the best overview I have read on this is an article by Steve Randall discussing the viewpoints of the Bank of Canada on this subject.3 Click here to read.

To Conclude…

I reiterate that the degree of uncertainty remains high. It is encouraging that the policy-makers are planning to reopen the economy in a staggered approach, confirming our entry into phase two of our recovery model. We do not want to be not a minute late in reopening the economy, but not a minute too soon for the health and welfare of everyone, most importantly our front-line workers.

We continue to receive appreciative comments from many clients on the series of communication memos we have been sending. Our office remains in operation for regular business hours and we can be reached by phone or email.

If you think you will need a withdrawal in the next six months, it is prudent to call us to potentially take advantage of this partial recovery. We have some positions and mutual funds that are neutral for the calendar year or slightly up, so we can trim some of these positions.

Todd Campbell
President, RBA

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