The COVID Crash: The Fastest Fall and the Fastest Recovery

*The market fell by a third in under five weeks, the swiftest such decline on record, and reached a new high within six months. Almost nobody predicted either half.*

Between the nineteenth of February and the twenty-third of March, 2020, the broad American market fell by approximately thirty-four percent. It was the fastest decline of that magnitude on record, compressing into five weeks a fall that had previously taken months or years. The cause was not obscure, and this is what makes the episode so instructive: everyone knew exactly what was happening.

A pandemic was spreading. Economies were being closed by government order. Businesses that depended on people gathering were being told they could not operate. The unemployment figures that followed had no modern precedent. There was no ambiguity about the nature of the shock, no complex financial instrument whose failure had to be traced, no fraud to be uncovered. The world had visibly and abruptly changed, and the market fell.

By August 2020, the same market had reached a new all-time high. The recovery took less than six months, and it occurred while the pandemic was ongoing, while much of the economy remained impaired, and while the course of the disease remained unknown. This is the fact that ought to be difficult for any investor to accommodate, and it is the reason the episode belongs in any serious education.

Consider an investor who, in early 2020, correctly anticipated the pandemic and its economic consequences. Their forecast about the world was substantially correct, and it was correct earlier and more completely than most. Acting on it, they sold. They were then confronted with a market that recovered fully within months, and faced the question of when to return, with prices already well above where they had exited.

This is the trap the episode illustrates, and it is worth stating precisely because it defeats the intuition most investors hold. A correct forecast about events is not the same as a correct forecast about prices. To profit from anticipating a decline, an investor must be right about the event, right about the market's reaction to it, and right about when to return. The first is difficult. The three together are close to impossible, and being right about only the first, as this investor was, is entirely consistent with being considerably worse off than someone who did nothing at all.

The explanation for the recovery is not mysterious, though it was not predictable. Extraordinary monetary and fiscal support was deployed with a speed and scale that had no precedent. Central banks reduced rates and purchased assets in enormous quantities; governments transferred money to households and businesses directly. Markets, which price expectations of the future rather than conditions of the present, responded to the prospect of a supported recovery rather than to the grim conditions then prevailing.

An investor who understood the pandemic perfectly but did not anticipate the policy response understood only half the situation, and the half they missed turned out to be the half that determined prices. This is a recurring feature of markets and it is deeply unintuitive: the connection between what is happening in the world and what happens to prices is mediated by expectations and by responses, and both can be entirely surprising.

The comparison with the other episodes in this series is where the lesson becomes clear. The 1929 decline took twenty-five years to recover. Japan took thirty-four. The 2008 decline took about four. The 2020 decline took less than six months, and Black Monday, more violent than any of them in a single session, took two years. There is no relationship whatever between the speed or severity of a fall and the duration of its consequences. An investor experiencing a decline has no way of knowing which of these they are living through, and the drama of the fall tells them nothing.

This is precisely why a framework decided in advance is worth so much more than judgement exercised in the moment. In the moment, the information required to distinguish a 2020 from a 1929 does not exist, and an investor who believes they can tell is mistaken about what is knowable. The investor who simply continued to hold, and continued to contribute, made no forecast at all and was rewarded for making none.

It should be acknowledged that this outcome was not guaranteed and that saying so honestly matters. The policy response could have been slower or smaller. The disease could have proved more destructive. An investor who held through the decline was not vindicated because holding is magically correct; they were vindicated because the recovery arrived, and it might not have. What can be said is that they placed themselves in a position to benefit if it did, which the investor who sold did not, and that the historical record suggests this is the more reliable position over many such episodes.

The episode also produced a striking divergence within the market itself that is worth recording. The decline had been broadly indiscriminate, but the recovery was not. Companies whose businesses were suited to a world of restricted movement recovered and then advanced enormously, while those dependent on physical gathering remained depressed for a considerably longer period. An investor holding a broad index experienced the average of these outcomes, which was a rapid recovery; an investor holding a narrow selection experienced something that depended entirely on which companies they happened to own. The point is not that one could have selected the beneficiaries in advance, since the identity of the winners was far less obvious in March 2020 than it appears now. The point is that the aggregate figure conceals an enormous dispersion, and that the comfortable statement that the market recovered in six months was not the experience of a great many people who owned parts of it.

At VESTFY™ the COVID crash is presented as the cleanest available demonstration that being right about the world is not sufficient. The people who best understood what was happening in February 2020 were not, as a group, the people who did best in the market that year. That fact should unsettle anyone who believes their edge lies in understanding events, and it is the most useful thing the episode has to offer.