What is a V Shaped Recovery?
The global stock markets have rallied since the beginning of March, reaching a point where the growth could technically be considered a bull market. However, whether we’ve reached a bull market at the bottom or a top at the bottom of the market, a double dip should be expected.
The V Formation
Very few stock markets have ever recovered in a purely V shaped recovery. This happens for a variety of reasons.
Reason 1: Traders Take Profits After the Bottom
The biggest reason for a W shaped recovery instead of a V shape is that investors often take profits after very short bull runs in a bear market. When the majority of the market is holding enormous losses, there are plenty of people who are willing to take 15-20% profits after a 50% dip. The middle tip of the W is often the point at which the last sellers exit the remaining of their positions to buy at the double dip base 10-15% below the current level.
Reason 2: Central Bank Policy
More often than not, early economic recoveries are the result of large infusions of cash into the economy. Essentially, a temporary amount of wealth is created until the market realizes how many dollars are flooding the economy and prices correct appropriately. By infusing large amounts of cash reserves, people as a whole have more money to spend at a value that is higher than its true market price. Thus, people spend again, but only while the money is good.
Reason 3: Bottoms Must Be Tested
The price at which investors are willing to buy or sell a security is forever changing. Often a bottom in the stock market is tested multiple times to find an “equilibrium” price or a true value of the security being sold. The value of a security is equal to the opinion of all investors proportionally to the amount of shares held by each individual. That is simply how any market works, especially markets as fluid and as liquid as world stock exchanges.
Reason 4: Rallies Aren’t Buying, Just Not Selling
The recent rally in the world’s stock markets could also be due to a large portion of investors liquidating short trades. Because shorters have to borrow shares to sell, they must also buy back shares to cover their positions. When short investors begin taking profits, the result is an increase in demand for shares, and as such, higher stock prices.
While some analysts and investors are attempting to claim that we have reached a V recovery, the truth is that only the second part of the W is coming.