It’s human nature to try to forecast the future based primarily on the recent past. Psychologists might say we are succumbing to “recency bias” when we do this. That is, placing too much weight on what has happened recently as we try to discern what will happen next. Our brains sometimes take this mental shortcut when digesting large amounts of information. But recency bias can introduce inefficiencies into financial markets as more recent but less relevant data points drown out more material information.

Decreasing lockdown restrictions and tentative signs that economic activity is reviving have propelled a rebound in risky asset prices. But while some may resume visiting theme parks, patronizing coffee shops and staying in hotels, not everyone will. Quite a few won’t feel comfortable boarding a plane or sitting in a crowded restaurant until a safe vaccine is widely available. So while a company operating at 75% of 2019 revenues is materially better off than the 15% level it may have operated at during the lockdown and naturally warrants a re-rating of its enterprise value, that re-rating should only go so far, and certainly not back to pre-COVID-19 levels.

Since investing is an exchange of capital for a stream of future cash flows, financial assets derive their value based on the market’s aggregated estimate of those prospective cash flows. Every company has fixed costs and thus a breakeven revenue level. At the risk of oversimplification, each new dollar of revenue above fixed costs is a higher-margin dollar. In other words, profits aren’t linear. The last customer is the most profitable. Scale matters a lot. And recapturing the remaining 25% of 2019 revenue is what will be material for investors.

As businesses reopen, albeit at reduced capacity, traffic will accelerate and sales comparisons will look strong due to base effects. Ultimately, what’s material for financial markets is whether companies regain pre-crisis margins at partial capacity.

Let’s explore what investors are signaling.

From the February 19 peak, Exhibit 1 charts the retracement of the S&P 500.

As shown above, a remarkable amount of the loss was recovered in a very short period of time.

Exhibit 2 captures the last four episodes in which the index fell by at least 20%.

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