The FTSE 100 has rebounded 17% from the lows reached less than three weeks ago. Last week, the index rose by 8%, registering three daily gains of over 2%. Alas, despite these gains the FTSE 100 is still well below where it was back in February.
It’s an unfortunate facet of mathematics that to recoup the 32% that the FTSE 100 lost from February to March, it must subsequently rise by a much larger 48%. And so the premier UK index is still 21% below its February level.
After having initially largely ignored Covid-19 fears, the market moved sharply downwards, before correcting itself and moving sharply upwards. This is a great example of how investors often either underreact or overreact to news.
Isaac Newton famously said that he could ‘’calculate the motion of heavenly bodies, but not the madness of people’’.
Were these moves justified?
Looking back, it’s hard to find anything that justified such sharp movements. Did the initial worries about Covid-19 really justify such sharp downward movements? Did we learn anything last week and the weeks before to justify such a recovery?
In my opinion, the answer to both these questions is no. Shares derive their value from their future earnings. In low interest rate environments, shares are valued on their ability to produce earnings over many years, not just one year. As such, it looks to me like the broad-based sell-off in the FTSE 100 was an overreaction, sparked by mass fear.
Likewise, the subsequent recovery also seems to me to be over-done. If anything, what we have learnt in the last couple of weeks is that dealing with Covid-19 is going to be very damaging to the economy. And this damage could last a while, too. The inevitable recession looks like it could be worse than anything seen since the Great Depression, some 90 years ago.
What will happen to the FTSE 100 next?
For share prices and the FTSE 100 to carry on rising, there needs to be more buyers than sellers. That has been the case over the last two weeks, with investors tempted back into the market by super low and attractive prices. But there comes a time when, after shares have risen, prices become less attractive, and new buyers dry up. Personally, I don’t think we are too far away from that time. Especially considering that we will soon begin to see what effect Covid-19 has had upon the economy.
In times of great uncertainty, investors react quickly to short-term news, moving share prices sharply in one direction. Investors tend to stick together, so if an investor sees the market moving abruptly downwards, they too will sell their stocks, and vice versa. These volatile movements in different directions are the market’s way of establishing an equilibrium. Over time, as the uncertainty reduces, stock prices will more closely reflect reality.
In the meantime, there are still some opportunities for investors to buy quality companies at undervalued prices. Albeit there are significantly fewer opportunities than there were just two weeks ago. But don’t worry about missing out, I have a feeling that there will be plenty more opportunities to buy into this crash. Just make sure to pay attention to value.