As I mentioned in my last missive, markets are reacting to expectations of the future rather than the horrors of the present. At the time of writing, despite its welcome recovery, the FTSE 100 remains 25% below its 2020 high, but in the thick of the uncertainties relating to the timing and severity of the peak of the daily deaths from the pandemic, it seems perverse to see such a strong bounce before any sign that the economically catastrophic lockdowns are to end. Even more so now that we know that the huge financial sectors (banks and insurances) will neither pay dividends nor continue their share buyback programmes for the foreseeable future.
I believe there are five reasons for the recovery.
i) Many initial price falls overshot. In the initial stages of any sharp selloff, the baby goes out with the bathwater. Prices fall indiscriminately, whether or not individual companies are exposed to the economic shock. There follows a period when analysts and fund managers apply greater logic to company share prices and the most oversold shares recover.
ii) The oil price has started to recover as the omens improve for the end of the price war between Russia and Saudi Arabia. The oil majors form a very significant part of the FTSE 100 index and its recovery has a proportionate effect on that index.
iii) During the initial phase of a sudden market sell off, share price falls are often exacerbated by shareholders (such as many hedge funds) who have purchased shares with borrowed money being forced to ‘unwind’ their leveraged exposures by selling shares. This contributes to an oversold position from where prices often recover.