US equities put up their best monthly gain since 1987 in April, just a month removed from one of the most harrowing crashes in market history.
Some are incredulous. The juxtaposition between depression-like data and a 30% rally off the local lows is simply too much for many market participants to countenance.
A portion of the frustration probably stems from missing out. But a good bit of it is likely real too – that is, it emanates from genuine concerns about the glaring discrepancy between, on one hand, the worst data in the history of modern economic statistics and the prospect of earnings being reduced to zero for many businesses, and, on the other, risk assets in rally mode.
Fed support is in play, yes. But so are other crucial dynamics, as detailed extensively here on Thursday morning.
It’s important to remember that bear market rallies are by no means uncommon. There’s usually serious “chop” around dramatic episodes before things finally settle.
I’ve spent quite a bit of time in these pages over the past month documenting the history of bear markets and the rallies within, but SocGen’s Solomon Tadesse is out with what he describes as “an exhaustive analysis” of historical swoons, which is well worth a mention.
Tadesse begins with an assessment of the well-documented disconnect that has so vexed many a market participant over the last three or so weeks. To wit:
While the pandemic purgatory is upending lives and ravaging global economies, financial markets appear to be an island of epiphany of sorts, with dramatic surges of historic proportions. The S&P 500 posted a staggering 31% gain in a matter of a month from its March bottom. By contrast, in one of the greatest bear market sprints, the market retracted only 15% from its bottom in the first month after the great crash of 1929, sustaining the gains for another four months to a height of 47%, before succumbing into a tailspin of decline for the next two years until it hit its ultimate bottom in June of 1932 during the Great Depression.
He goes on to note that market bottoms need not entail the onset of positive news flow around whatever it is that caused the crash – rather, the news just has to be less bad going forward.
The problem, though, is the prospect of structural damage, something I’ve brought up repeatedly, including on Thursday morning in the context of the latest jobless claims figures. Specifically, I raised the specter of permanently altered consumption habits and noted that if society has, in fact, changed, and people interact with each other differently going forward, there may never be a full recovery for the vast US services sector.
SocGen touches on this. “It is, however, curious that the March bottom has discounted a permanent shift in unemployment, a significantly shrunk economy and potentially slower consumption growth beyond the immediate crisis period”, Tadesse writes.
He looks back at 150 years of market history – so, from 1870 to 2020. Here’s a bit of color which explains what they included in the sample”
Adopting the conventional definition of bear markets as periods of 20% plus drops in prices from previous tops, there were close to 30 bear markets during the period that covers two great wars, four major depressions, two market crashes, and two oil crises. We included declines near the 20% mark in our definition; thus, we have the Christmas Fed-tightening-induced market drawdown of 2018, for example… While each down- market may appear unique in its dynamics, it can be argued that there may be commonalities in the pre-and post-market-bottom patterns that could be inferred with greater clarity, given sufficient sample size of such episodes in this long time series
The obvious question (and the point of inquiry from the note) is how the current bounce compares to stocks’ reaction to past bear market bottoms.
Tadesse plots the cumulative performance, averaged, of all bear markets over a century and a half, with performance shown three years going into the crash and four years coming out the other side, following what, in hindsight, we know was the bottom.
Needless to say, this crash was among the swiftest in history, something documented in “Speed Demon: Fastest Bear Market In History Leaves Traders Reeling“. Just as the descent to the bottom was faster this time, so too has been the rebound. On average, stocks rise 11% in the initial three months off a bear market bottom and around 25% within a year, SocGen says. That trajectory does not change when you include the Great Depression in the sample.
In the left pane below, there’s a separate line for “severe bear markets”, a category which includes epochal episodes that changed history. Included in that sample are World War I, the Crash of 1929, The Great Depression, the Oil Crisis, and Black Monday.
“By definition, the steepness of the fall is more dramatic for these episodes [but] the path of post-crisis price recovery is not significantly different from the average of all bear markets, providing an element of robustness to a natural course of price recovery”, Tadesse notes. The green arrow in the left pane shows that if the March lows were, in fact, the bottom, we are well ahead of history in terms of the market recovery.
The implication is that if you assume March did mark the lows, the S&P 500 should close 2020 somewhere in the neighborhood of 2715. The range could be estimated between 2660 to 2772. Again, that’s based on the trajectory of equities around historical bear markets, both of the “normal” and history-altering variety.
The right pane above is simply meant as a cautionary tale. Tadesse gingerly reminds you that “history is also replete with many instances of flimsy bear rallies that eventually succumbed to yet another, lower bottom [with] the classic case [being] the staggering 47% rally over the four months immediately after the bear bottom of the 1929 market crash”.
Of course, this time could be different. After all, modern markets are unique, evolved beasts, which goes a long way towards explaining why this crash was so dramatic (i.e., rapid) and the subsequent bounce so furious.
In addition, there has never been an instance of policy support on the scale witnessed currently. The following chart from Deutsche Bank is on a log scale (left) just so you can wrap your mind around it.
Summing up, Tadesse writes that “with the current fallout from the complete shutdown of economic life in terms of disruptions in supply chains and collapse of aggregate demand, as well as the uncertainty on the post-lockdown path to recovery, new market bottoms are possible”.
And yet, they readily admit that “the unprecedented massive policy response could provide the backstop to a worsening case of deflationary spiral”.