By Toviya Slager
From late February 2020 to the end of June 2020, the market sent many varying signals, leading to much financial insecurity. What was the longest consecutive bull market in history, was seemingly followed by the shortest bear market in history. Investors are now questioning how a long bull market can be followed by such a short bear market. Additionally, investors are left to speculate: is the v-shaped recovery a one-time anomaly, or a preview of another crash?
When trying to better understand market patterns, investors use a method known as technical analysis, which consists of looking at recurring patterns in similar economic contexts. This method is commonly practiced because the market has a high tendency of repeating itself. In previous bear markets, such as the Dotcom Bubble and the Great Recession, the crash lasted many months and had a gradual recovery, as seen in the S&P 500 graph (top) by Macrotrends. The COVID-19 induced recession is quite the opposite, as the decline and recovery lasted for only a month. The traditional methods of technical analysis prove to be ineffective when examining this recession. Additionally, the general uncertainty tracker for the stock market, the VIX (Volatility Index), hit a high of 66 on March 16, only to decline to 30 by late June, as seen in the Macrotrends VIX graph (bottom). For context, the VIX is usually around 20, indicating the vast uncertainty about the market. This uncertainty may come from the recent rise of cases in states such as Texas and Florida as well as a potential second wave of COVID-19 cases which could bring the market to its knees again.
Another element that has further added unclarity is whether the stock market’s performance is a true indication of the actual market. With cases nationwide increasing rapidly, an unemployment rate of over 10%, and many major companies filing for bankruptcy, it seems highly improbable that the stock market should be ticking up — yet it is. Often this can be associated with investor optimism. Meaning, people believe that the economy will recover quickly despite data indicating otherwise. However, recently conducted polls show that investor optimism is currently at its lowest point since 2015. This contradiction paints an unclear picture about what is driving the market and why it is not reflecting a more accurate state of the economy.
With such unpredictability in the market, the logical investment approach would be one of great caution. However, some companies are aggressively investing. For example, PNC sold $14 billion in shares without stating the use of the proceeds. Many companies are filing for IPOs, including Shift4 (FOUR, $345 million), Warner Music Group Corp. (WMG, $1.9 billion), and Vroom Inc. (VRM, $468 million). IPOs generally do not occur in a bear market since companies believe that they will not be able to generate the revenue they want. Additionally, unstable markets keep IPOs from debuting for the same reason investors are skeptical to buy new stocks: quick devaluation. Yet, these IPOs were remarkably successful and show strong investor confidence pertaining to the state of the market. On the other hand, there have been no major IPOs — defined as ones larger than $5 billion or larger — which suggests that larger companies are still wary of exposing themselves to an unstable market.
Another interesting trend within the IPO market is the rise of special purpose acquisition companies (SPAC). SPACs are shell companies that raise money through the IPO market in order to acquire other companies. In April 2020, about 80% of the funds raised for IPOs went to SPACs, compared to 8% in a normal market. Many investors are placing their bets that these SPACs will be able to capitalize on the companies that survive through COVID-19. However, an interesting development happened when Bill Ackman recently decided to try and raise $6.5 billion for the largest SPAC IPOs ever. Although he might be opportunistic and hope to find an undervalued company in this uncertain market, it also indicates his optimism for finding enough investors who are bullish on his SPAC.
Another area that seems to side more strongly with the volatile side is the Mergers and Acquisitions (M&A) sector. Many companies have abandoned their M&A activity due to COVID-19. For example, SoftBank stopped their $3 billion offer for WeWork shares. This shows that companies prefer to retain security in the form of liquidity as well as their skepticism of receiving a fair valuation. However, there are some companies which have taken advantage of the current crisis and have made acquisitions. For example, Lululemon announced on June 30 they are buying Mirror for $500 million. Another example is GrubHub’s planned acquisition by Just Eat Takeaway for $7.3 billion. Also, Uber recently agreed on July 5 to buyout Postmates for $2.65 billion.
In the context of IPOs and M&As, it is important to discuss the huge new barrier that is stopping many companies from doing IPOs — digital operational due diligence (ODD). In the past, companies would be partially valued based on their workspace and work dynamic. However, due to COVID-19, work has been moved primarily online and performing these assessments remotely have become exceedingly difficult. Many investors have a difficult time trusting the level that the ODD can be performed, but have slowly realized the need for virtual roadshows and relied on them for investment opportunities.
With economic stress pulling companies at the seams, many companies have moved to restructuring to create financial flexibility. For example, Unilever announced it would restructure by combining its Dutch and British offices into one office. This would allow it to run and create new deals more smoothly. Additionally, Chuck E. Cheese announced that they plan to undergo restructuring as part of filing for chapter 11 bankruptcy. They had invested in many new locations that were not able to open due to COVID-19 causing massive losses within the company. Macy’s is laying off about 3,600 employs in an effort to save $365 million this year and $630 million per year in the future. This restriction will dramatically reduce overhead costs for the organization. Brooks Brothers announced on July 8 that they will also be filing for chapter 11 bankruptcy and restructure the company. They have been suffering for the past few years, but COVID-19 forced them into bankruptcy. They are looking to be bought by another company and plan on closing dozens of stores to recoup losses created by COVID-19.
With such a chaotic market, remaining conservative with defensive investing should be the widespread strategy. Yet, there are companies that are more comfortable with the economic climate to file for IPOs and M&As. This highlights the polarity between investors about the certainty of the economy’s recovery. While some believe that the market still needs to fall before it stabilizes, other optimistic investors believe that much of the recovery has already occurred and the economy will tick up from now.
S&P 500 Graph (top) Source: https://www.macrotrends.net/2324/sp-500-historical-chart-data
VIX Graph (bottom) Source: https://www.macrotrends.net/2603/vix-volatility-index-historical-chart#:~:text=Historical%20Chart%20%7C%20MacroTrends-,VIX%20Volatility%20Index%20%2D%20Historical%20Chart,July%2002%2C%202020%20is%2027.68.