Liquid Strategies Insights & Commentary

Market Bottoming Process

Author: Shawn Gibson
Shawn Gibson

 

Given the high level of uncertainty regarding COVID-19, it is impossible to estimate what the final market bottom will be. The final low water mark will be a function of a number of factors, including, but not limited to:

1) The availability of widespread rapid testing

2) The development of treatments for patients having an adverse reaction to the virus

3) The timing of businesses reopening to once again allow consumer spending

4) The magnitude of financial and fiscal stimulus to provide relief to our citizens and businesses that are struggling during this shutdown

A market bottom coming out of crisis is typically a process that takes time and requires an equilibrium to be established between investors that throw in the towel and investors that recognize extreme value and are sufficiently capitalized to take advantage of the opportunity. While there is no precedent for what we are experiencing today, examining the bottoming process of the 2008-2009 Credit Crisis might be helpful in setting expectations on how this might take place.

As the chart below shows, in late September of 2008, the major waterfall lower caused the S&P 500 Index to fall about 33% in the course of a few weeks. This decline was followed by a sharp rally of almost 25% in just a couple of trading days. While this marked a short-term bottom, it was only the beginning of a longer bottoming process. The equity markets made a new short-term low in November 2008 and then rallied into January 2009 before starting the final multi-month decline before the market made a final bottom in March 2009. The important points here are that the bottoming process will likely come with wild market swings in both directions, will likely take months to complete, and identifying the final low point will only be possible long after it takes place.  One interesting point is that the CBOE Volatility Index (“the VIX”), which roughly measures estimated future equity volatility, the solid black line in the chart, actually peaked well before the market bottom.  A stabilization of the VIX at lower levels might be a useful guidepost to consider as an indication of increased market stability and a sign that the bottoming process may be closer to the end rather than the beginning.

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The assertions and statements in this blog post are based on the opinions of the author and Liquid Strategies. The examples cited in this paper are based on hypothetical situations and should only be considered as examples of potential trading strategies. They do not take into consideration the impact that certain economic or market factors have on the decision making process. Past performance is no indication of future results. Inherent in any investment is the potential for loss. 

Topics: Overlay

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