When will the stock market recover?

There are three key scenarios investors should be planning for.

After Australia's fastest ever fall into a bear market, the last week offered hope that a stock market recovery might be just as dramatic, with the benchmark S&P/ASX200 index rising by a record 7% Monday.

The big question now is whether the market might be nearing the bottom – or whether we've already passed it.

Investors know that a bear market (a price fall of 20% or more) is a good opportunity to buy stocks at low prices. Unfortunately, nobody can be certain whether prices will continue falling for months to come or if they're on the verge of rebounding, say, tomorrow.

The broad views from analysts aren't promising. In a note last week, Goldman Sachs analysts estimated the US stock market (S&P/500 index) would continue falling by another 20% within the next few months and would be unlikely to recover to February heights before next year.

Others estimate a sharper recovery within the next few weeks or alternatively a long-winded recovery that could take many years.

While it's difficult to time the market – or impossible, depending on who you talk to – there are a few signs that analysts say are likely to precede the stock market recovering:

• New COVID-19 infection rates drop
• Governments work together to control the pandemic
• The oil price war comes under control
• Analysts are confident there wont be a credit crunch
• Stock price volatility starts to drop

Types of crashes

There are three kinds of market crashes according to Goldman Sachs. These are event-driven, cyclical (occurs every few years) and structural (deeply-rooted financial/economic issues).

What we do know is that the current market crash started as event-driven – a pandemic that's forcing businesses to close doors.

Event-driven crashes tend to result in a quick rebound (aka a "v-shaped recovery") as we saw during the SARS outbreak, where stocks reached previous peaks after about six months.

Aussie sharemarket (S&P/ASX 200) from November 2002-July 2003 (SARs period).

The problem is the longer businesses are forced to stay shut, the greater chance we'll transition to a "structural" crash driven by financial and economic collapses.

Structural market crashes include the 2008 global financial crisis, the 1987 Black Monday market crash and the 1929 Great Depression, where stocks can take up to a decade to fully recover to pre-crisis prices.

After the GFC, Australia's stock market continued its downward trajectory for six months before it started to recover. It took 11.5 years for stocks to reach previous peaks. At the same time, most other market downturns took less than two years to reach previous heights and started recovering after one to three months.

All-Ords historical stock market crash triggers. Image: Finder

To put it into context, below is the average length and recovery time of each type of bear market according to recent research by Goldman Sachs:

Structural bear market

• Average recovery time: 9.2 years
• Average length: 3.5 years

Cyclical bear market

• Average recovery time: 5.2 years
• Average length: 2.3 years

Event-driven bear market

• Average recovery time: 1.3 years
• Average length: 9 months

Wait for volatility to settle

The current market crash stands out from any other because of its extraordinarily high volatility. While big price movements can be a traders best friend, it's also a risky market for inexperienced investors.

Part of the reason is that we've never had a global health crisis like this before, which makes it largely unpredictable.

According to Burman Invest's chief investment officer Julia Lee, high volatility usually lasts around two to three months when there is a panic-driven market crash. This means we probably have at least several more weeks to go before stocks start to settle and (fingers crossed) rise.

"Don’t get scared that you’re going to miss out on the gains when you do see these big 5 - 7% gains in one day," said Lee.

"One of the characteristics of a market like this is that not only do you see big moves down but you also see big moves up."

Don't panic buy in

The danger of buying shares during a stock market crash is that prices continue falling and in worse case scenarios may not recover. This is known in the investment world as attempting to "catch a falling knife", for obvious reasons.

To avoid this, Lee said investors should look for a decline in volatility as a sign that it could be a good time to start entering the market.

"These panics really only happen once in a decade, so while they can be terrible wealth destructors, they also represent a 10-year opportunity," said Lee.

Dale Gillham Chief Analyst at Wealth Within advises investors to be patient, rather than jump in for fear of missing out.

"When it comes to investing, there are times to buy, times to sell and times to sit back and watch. Right now it's time to watch and wait for the dust to settle," advised Gillham.

"Investors are wanting to get into the market prematurely for fear of missing out on the inevitable rally, but sadly many will get burnt as they will misread the market.

"It's far better to sit on your hands and do nothing than get into stocks too early."

Australia vs United States recovery

One of the key signs that analysts are looking for ahead of a market recovery is a global drop in coronavirus infection cases.

Since Australia's stock market is directly influenced by what happens on Wall Street, Lee says there are three key scenarios investors here should be preparing for.

If we find that the pandemic is seasonally affected, infection rates might rise in Australia as winter sets in over the coming months and drop in the US as summer approaches.

That scenario could see Australia's stock market continue to fall even as global stock markets in the US and Europe start to recover.

The second scenario is that both countries are able to get the pandemic under control and the worst-case scenario is that both countries continue to see rising infection numbers.

To prepare, start by looking over your portfolio of stocks and consider how each scenario would impact prices. You may need to consider further diversification at this point or simply mentally prepare to ride out the storm.

Lee says it's best to imagine where you'll be in two years' time from now, and looking back consider what you probably wished you had done.