T. ROWE PRICE INSIGHTS ON MULTI-ASSET INVESTING The Five Stages of a Market Crisis From denial to acceptance. May 2020 KEY INSIGHTS ■■ The Kübler‑Ross model outlines a series of emotions experienced by terminally ill patients and the recently bereaved. A similar process can be observed in market crises. Yoram Lustig Head of Multi-Asset Solutions, EMEA ■■ I believe the coronavirus crisis is currently in the “depression” stage, at which assets have adjusted in line with the new reality. ■■ The “acceptance” stage will only arrive when infection rates drop and the end of lockdowns and social distancing is in sight, which could still be months away. he Kübler‑Ross model, also Bank of New York method for calculating known as the five stages of grief, probability of a U.S. recession 12 months Tfamously outlines a series of forward, the U.S. yield curve assigned emotions experienced by terminally around a 30% probability of a recession in ill patients prior to death or by people February 2020. This may not sound very who have lost a loved one. Beginning high, but the last two occasions it reached with denial, the model describes such levels during the past 30 years were paths through each subsequent stage: at the beginning of the recession in 2000 anger, bargaining, depression, and and just before the 2008 global financial acceptance. In my view, a similar crisis (Figure 1). sentimental process—with a few adjustments—can be observed in While the bond market did not predict market crises, including the present the coronavirus pandemic, it did warn one, where I believe we are in the us that something bad might happen “depression” stage. in markets. More importantly, however, when the coronavirus ravaged China, the Let’s look at each stage in turn. West remained in denial. We watched as China put Hubei province into quarantine, Denial: With the benefit of hindsight, built a hospital in a week, closed Wuhan, we were in denial for quite some and shut down the national economy. We time. In the summer of 2019, the U.S. yield thought the coronavirus was nothing more curve inverted when the spread between than flu with more aggressive PR. To fully yields of 10‑year Treasury notes and understand the crisis, we had to see it with three‑month Treasury bills dropped to our own eyes in Europe and then in the almost ‑50bps. Using the Federal Reserve U.S.—only then could we stop denying it. 1 The U.S. Yield Curve Signaled a Recession Last Summer (Fig. 1) The probability of a U.S. recession, using the New York Fed’s model 50 Probability of Recession Recession 40 February 2020 30 Percent 20 Average 10 0 Sept. Aug. Jul. Jun. May Apr. Mar. Mar. 1992 1996 2000 2004 2008 2012 2016 2020 As of March 31, 2020. Sources: Federal Reserve Bank of New York, The Yield Curve as a Leading Indicator, https://www.newyorkfed.org/research/capital_markets/ycfaq.html, with analysis by T. Rowe Price. Based on U.S. generic spread rates September 1992 through March 2020. The shaded areas indicate periods designated as recessions. Actual outcomes may vary. Anger: Bear markets typically Bargaining: Bargaining has two We thought the begin with a steep drop in the meanings in a market crisis. The coronavirus was prices of risk assets—panic or fear would first is the initial attempt to address and perhaps be more appropriate words bargain with the unfolding crisis. With nothing more than anger. When confidence is lost, the coronavirus, central banks were sentiment turns sour and investors quick to react to this crisis with than flu with more dump risk assets in favor of conservative unprecedented monetary stimulus. They aggressive PR. investments. Liquidity evaporates, prevented the situation from turning into making things worse. a financial crisis by providing liquidity, purchasing assets, and printing money On February 20, 2020, the drawdown for governments. Then governments in risk assets began, sending the MSCI announced unprecedented fiscal All Country World Index (ACWI) down stimulus and programs to support 33% and global high yield indices down individuals, businesses, and the more than 20% by March 24. Yields of economies. They also took decisive high‑quality government bonds (e.g., measures to address the health crisis those of the U.S., Germany, and the UK) through travel bans, lockdowns, and reached all‑time lows, and “safe‑haven” social distancing. The actions of currencies, such as the U.S. dollar and policymakers ensured that markets, Japanese yen, appreciated. The descent instead of irrationally pricing in doom into bear market territory of the S&P 500 and gloom, resumed trying to weight was more rapid than ever previously probable scenarios and price them in. witnessed—perhaps because of the surprising shock of the virus, perhaps The other form of bargaining is the because it started from all‑time highs market capitulation that occurs when of stock markets, and/or perhaps markets are oversold and bargain because algorithm trading exacerbated hunters buy assets at depressed prices. the selling (see Figure 2). In the angry When those who panicked have fled, stage, markets quickly price in doom we are left with three broad categories and gloom. This initial stage of an angry of investor: those who take the view meltdown now appears to be behind us. that selling now is probably the wrong 2 This Year’s Record Descent Into Bear Market Territory It is not yet clear (Fig. 2) Cumulative total returns of selected bear markets of the S&P 500 whether markets 0 indeed reached -10 -20 1990 their lows on -30 Percent 1987 March 23, 2020... -40 2020 -50 2007 2000 -60 637600550500450400350300250200150100501 Number of Trading Days Past performance is not a reliable indicator of future performance. As of April 20, 2020. Source: Standard and Poor’s S&P 500 Index (see Additional Disclosures), with analysis by T. Rowe Price. January 1960 through April 20, 2020. The x‑axis is the number of trading days from the peak to the trough of the decline, except for the 2020 bear market where the x‑axis is the number of trading days from February 19, 2020, to April 20, 2020. A bear market is defined as a drop of 20% or more from the peak. The figure shows only a few selected bear markets of the S&P 500 since 1960. decision (because it crystallizes losses), Typically for a bear market, there is a those who add risk because prices are rally following the initial sell‑off. In the attractive (taking the view that it is a week of March 23–27, 2020, ACWI buying opportunity and risk assets are delivered its best weekly return since likely to recover), and those who entered 2008, and its recovery from its bottom the crisis with an overweight to risk on March 23, 2020, was over 25% until assets and now aim to make back some April 20, 2020. As the initial meltdown of their losses by adding more risk in an was unprecedentedly quick and steep, attempt to outperform the recovery. so was the rally. In Previous Bear Markets, Lows Have Typically Been Retested (Fig. 3) Cumulative total returns of the S&P 500 in the 1929, 1987, and 2020 bear markets 1929 and 2020 1987 and 2020 32 1929 (Left Axis) 3,500 350 1987 (Left Axis) 3,500 2020 (Right Axis) 2020 (Right Axis) 28 SPX Index SPX 3,000 300 3,000 Index SPX 24 SPX Index SPX SPX Index SPX 2,500 250 2,500 20 16 2,000 200 2,000 Number of Trading Days Number of Trading Days Past performance is not a reliable indicator of future performance. As of April 20, 2020. Source: Standard and Poor’s S&P 500 Index (see Additional Disclosures), with analysis by T. Rowe Price. SPX Index= S&P 500 Index. S&P incepted in 1957. S&P 500 data includes proxy returns prior to formal index inception in 1957 and is sourced directly from Bloomberg Index Services Limited. Chart on the left: January 2, 1929, through December 31, 1929, and May 24, 2019, through April 20, 2020. Chart on the right: January 2, 1987, through December 31, 1987, and June 5, 2019, through April 20, 2020. 3 It is not yet clear whether markets largely thanks to the measures that indeed reached their lows on March 23, policymakers have been implementing 2020, or whether the surge that to address both the health crisis and followed was merely a bear market rally the economic crisis. or a dead cat bounce—we will know that when we have the benefit of hindsight. The question that markets are now In previous bear markets, stock markets grappling with is: What is the likelihood have typically bounced after the initial of further negative or positive surprises? fall only to retest their lows again It is a difficult question to answer as later—often several times (see Figure 3). there are so many unknowns. It seems While we may have started a bottoming we have enough monetary and fiscal process, volatility needs to recede stimulus to bridge the crisis and perhaps before we can say with certainty that the fuel the next expansion and bull market, worst of the stock market downturn is but we may need a credible health behind us. The stage of bargaining may strategy before it is safe for workers and be over, or we may have a W‑shaped consumers to return to normal activity. bargaining stage with rally, sell‑off, and Until then, stock markets might struggle another rally.