As the scale and scope of the coronavirus outbreak became clear, stocks started falling in late February. The S&P 500
It's difficult to come up with a high-conviction stance given the massive amount of variables including the virus' spread, public buy-in, and policy response. However, one tool is to look at previous market crashes and see how stocks recovered.
2010 Crash
The 2010 crash is known as the "flash crash". From the end of April to the middle of May, the S&P 500 dropped more than 20%. Over the previous year, the S&P 500 had been in a relentless bull market as it moved off its bottom from the Great Recession. Over this period, the economy continued to deteriorate, although the rate of deteriorating was improving. There were also concerns about the debt crisis in Greece, and the political stalemate in the European Union about how to handle it.
There was also a belief that this was a "bear market rally" which would roll over to new lows. Amid this environment came the "flash crash" which erased nearly a third of the gains of the previous year in mere weeks. After this steep decline, stocks remained range-bound for the next four months, until it broke out to new highs in September as the Fed implemented QE2.
In hindsight, it's clear that this was a fantastic buying opportunity. There was no inflation which would constrain the Fed, stocks were reasonably valued, and the economy was slowly healing.
1987 Crash
In 1987 from mid-August to early-October, the stock market dropped by nearly 40%. From the bottom, stocks traded in a range before resuming their ascent. Stocks had been in a bull market for the past five years after recovering from a multiyear bear market with high inflation and unemployment. The 1987 crash was due to a variety of factors beyond just being overbought including the use of mechanical, trading strategies that exacerbated selling as stocks moved lower.
The 1987 crash resulted in the Fed taking a more active role in its role as "lender of last resort". It also led to circuit-breakers which would prevent these types of sell-offs feeding on itself to become even worse.
2020 Crash
Some clear differences between the two previous dislocations and the current one are that they happened early in bull markets following extraordinary advances when there was still a great deal of uncertainty about the economy. In contrast, this is happening relatively late in the cycle.
Additionally, the issues which precipitated the previous crashes had political or regulatory solutions. They were more market failures, and there were concerns that it could lead to stress in the economy. This time, the problems are economic which are affecting financial markets.
For these reasons, lower stock prices are likely in the coming months. Range-bound trading is a best-case scenario. These problems are not political which are often solved when financial market stress forces policymakers to take bold, aggressive action as they did in 1987 or 2010. This time, the foe is exogenous, and the only way to defeat it is to shut down the economy for an unspecified period until it can be defeated.
