Stocks have recovered some of their losses since markets sold off so dramatically when the Covid-19 pandemic began to unfold earlier in the year.
But investors expecting a rally like those seen after previous crises should consider their next investment decisions carefully, according to US factor analytics firm Style Analytics.
Damian Handzy, chief commercial officer at Style Analytics, noted that in the month after the Covid-19 crash began on 19 February, both the US and UK markets fell by more than 30 per cent (in price terms, dominated in local currencies).
Since then, however, stocks have recovered to levels that aren’t quite as stomach-churning – albeit remaining substantially lower than they were pre-coronavirus.
Performance of indices since 19 February
Source: FE Analytics
But does this mean that the recovery has started in earnest, questioned Handzy.
“The ‘Black October’ crash of 1987 was quick – it lasted three months and investors lost a third of their money,” he said. “The global financial crisis of 2008 lasted 16 months and saw markets drop 49 per cent and the TMT crash of 2000 lasted 33 months for a loss of 45 per cent.
“And for those old enough to remember the 1973/74 oil crisis crash, the UK stock market plummeted 73 per cent over two years. Against this backdrop of history the Covid-19 crash looks mild.”
He added: “If the Covid-19 crash has truly ended it was the shortest crash ever.”
Handzy said the current rally may just be a “brief rise” in the middle of a larger and longer overall market crash if previous examples are anything to go by.
Or maybe it “truly is unique”, given the significant amount of support and huge sums of money promised by governments to help support their economies.
Nevertheless, said Handzy, there are a number of questions about the nature of the current rally. And this could have a significant impact on the types of stocks that perform well as we progress.
He explained: “If we have yet to feel the depths of the Covid-19 crash, then low volatility stocks, quality and large companies will outperform as we continue to sink.
“If we have seen the bottom already then value, smaller companies, high yield and high volatility stocks should outperform, in other words: those types of shares that historically do well in a recovery from a crash.”
Performance of UK factor indices since 19 February
Source: FE Analytics
As the above chart shows, quality and growth stocks in the UK have been among the best performers since the market crash on 19 February – losing less than the value and minimum volatility investment styles.
While the market downturn was similar to historical ones in that high volatility stocks did badly and there was a flight to quality, the growth and momentum styles have shone because they have negative exposure to value stocks.
Both styles also have positive tilts towards large-cap stocks that have been able to weather the downturn better and some of the higher volatility names.
“Successful risk management is about avoiding the biggest losses, and that’s exactly what growth and momentum stocks have been doing,” Style Analytics noted in its most recent analysis.
When the recovery does begin in earnest, Handzy said investors should remember that typically recoveries take longer than crashes and – as such – average monthly rises will be lower.
However, there is another possibility.
Style Analytics believes the recovery will be unlike any of those that markets witnessed previous and is likely to unfold in two phases, the first of which has already begun.
Handzy said the first phase is one fuelled by government stimulus and “easy cash”, rewarding companies that have done well in the past – the momentum trade – as well as those that have strong growth prospects and the fast-growing technology stocks.
Performance of momentum stocks since 19 February
Source: FE Analytics
The second phase, said Handzy, is likely to be fuelled by increased consumer spending and confidence as lockdown ends and life begins to return to normal.
This phase will reward investors in value, small cap, income and high volatility stocks, he said.
“If this is a two-stage recovery, that means as phase one ends markets will move down again before phase two kicks in,” Handzy concluded. “So, have some dry powder to take advantage of the dip.”