The 2020 pandemic crash and recovery

What you will learn

• The timeline and size of the crash from February to March 2020
• Why even normally liquid markets came under strain, and how central banks and governments responded
• Why the recovery started while the news was still bad
• How rebalancing during a crash works with numbers

Explanation

Volatility interruptions and trading halts are explained in the order-book course; here we look at the crash as a whole.

The fall

On 19 February 2020 the S&P 500, an index of 500 large US companies, closed at a record 3,386.15. As the coronavirus spread and countries announced lockdowns, it fell about 34% to its low on 23 March 2020, in just over one month. In March, US markets triggered market-wide trading halts several times. The VIX, an index of expected US stock volatility derived from option prices and often called the "fear index", reached its highest close on record, above 80.

A bear market is usually defined as a fall of at least 20% from a high. This one began and ended within weeks, which made it one of the fastest in history.

A dash for cash

In mid-March many investors and companies wanted cash at the same time. Prices fell not only for shares but also for corporate bonds, gold and, for a few days, even US government bonds. A liquidity crunch is a situation where many people want to sell and few want to buy, so prices move far even in usually deep markets. Oil was hit hardest: on 20 April 2020 the expiring US crude oil futures contract settled below zero, because storage was nearly full (the commodities course explains futures expiry).

The policy response

• The US Federal Reserve cut its policy rate to 0–0.25% on 15 March 2020 and bought large amounts of bonds.
• On 18 March the ECB announced the Pandemic Emergency Purchase Programme (PEPP) with an initial €750 billion.
• Governments, including Germany, expanded short-time work schemes (Kurzarbeit), loans and guarantees for companies, and direct aid.

The recovery

Markets look forward. Once investors believed that the worst case (a long depression with a broken financial system) was unlikely, prices rose although infections and unemployment were still increasing. The S&P 500 closed at a new record on 18 August 2020, about six months after the peak. To get back from a −34% low, the index needed a gain of about 52% (1 ÷ 0.66 − 1).

The recovery was uneven. Technology and online businesses gained, while airlines, travel and many banks lagged for much longer. An index investor recovered quickly; an investor concentrated in hard-hit sectors did not.

Lessons

• Crashes can be very fast; there may be no time to "react" once the fall has started.
• The low often comes when the news is still terrible. Waiting for clarity usually means buying back higher.
• Policy responses matter, and they differ by crisis: in 2020 they were faster and larger than in 2008.
• A written rebalancing rule turns panic into a mechanical decision.

Worked example

Hypothetical example: an investor holds €50,000, with a target of 70% equities and 30% bonds. Assumptions: equities fall 34%, bonds stay flat; afterwards equities rise 50% from the low and bonds stay flat. Costs, taxes and dividends are excluded.

1. Before: equities €35,000, bonds €15,000.
2. At the low: equities €35,000 × 0.66 = €23,100; total €23,100 + €15,000 = €38,100 (−23.8%).
3. Rebalance to 70/30: target equities €38,100 × 0.70 = €26,670. Buy €26,670 − €23,100 = €3,570 of equities, paid for by selling bonds (bonds now €11,430).
4. After the rebound with rebalancing: €26,670 × 1.5 + €11,430 = €40,005 + €11,430 = €51,435.
5. Without rebalancing: €23,100 × 1.5 + €15,000 = €49,650.
6. Investor who sold everything at the low and waited in cash: €38,100.

In this example, rebalancing added about €1,800 and selling at the low cost over €11,000. In a crash that keeps falling, rebalancing would have increased the loss in the short term, which is why the rule must be one you can follow in both cases.

Common mistake

Practice activity

On paper: a hypothetical €20,000 portfolio has a target of 60% equities and 40% bonds. In a crash, equities fall 30% and bonds rise 2%. (1) Calculate the new values and total. (2) What is the drawdown? (3) What is the new equity weight? (4) How much must be moved from bonds to equities to restore 60/40?

Key takeaways

• In 2020 the S&P 500 fell about 34% in roughly five weeks and reached a new record about six months after the peak.
• A liquidity crunch can hit almost every asset for a short time.
• Fast, large policy responses helped markets turn while the economic news was still bad.
• Rule-based rebalancing helped in this example; panic selling locked in the loss.

Next step

In the next lesson you will look at the repeated booms and busts of crypto markets and what they have in common with older bubbles.