It’ll seem obvious in hindsight, as all things do.
If the post-pandemic rally in equities ends up a smoldering ash heap, we’ll chuckle incredulously at the sheer audacity inherent in the scope of the bubble we created.
There are innumerable ways to visualize what some contend was unabashed folly, but the figure (below) from SocGen’s Solomon Tadesse is among the most poignant I’ve seen. It’s as astounding as it is elegant.
The chart shows performance around all observed bear markets going back 150 years. The sample includes the Great Depression.
As Tadesse wrote in a sweeping note out Thursday, post-crisis gains “were much slower historically with the average stabilizing around 40% by the second-year anniversary from a typical bear market bottom.”
The post-pandemic surge, by contrast, peaked at an eye-watering 113%, a mind-bending rally indicative of an “unprecedented asset bubble induced by excessive liquidity,” as Tadesse put it.
Now, central banks, including and especially the Fed, have the unenviable task of engineering a controlled demolition of the monumental rally they helped facilitate in the interest of curbing the wealth effect, which is contributing to the highest inflation in four decades.
As a reminder that no one needs, the cumulative increase in the value of household equities from Q2 2020 to Q4 2021 exceeded $22.5 trillion. The $3 trillion in value destruction seen during Q1’s selloff barely made a dent (green shaded area in the figure, above).
Some have suggested the Fed wouldn’t be terribly upset to see the entirety of the pandemic stock surge evaporate if it means quelling inflation and doesn’t manifest in too much pain for the real economy. Of course, the idea that the market cap equivalent of several major economies can just disappear into thin air without meaningful spillover to Main Street is a pipe dream. There’s still a pain threshold for policymakers, it’s just much higher now given inflation realities. Said differently, the vaunted “Fed put,” to the extent it still exists, is struck far, far lower than spot, even after a 24% drawdown from January’s record highs on the S&P.
So, where’s the bottom? Well, that’s the multi-trillion dollar question. Most of the de-rating is probably behind us, but earnings estimates are the next shoe to drop. Even if you assume some modest re-rating later this year as markets begin to anticipate a Fed pause, a drop in earnings consistent with the median decline in post-War recessions would still entail significant downside for stocks assuming (generously) a 17x multiple.
For his part, Tadesse wrote that “to be consistent with the historical post-crisis market valuation trend line, the cumulative returns as of today, since the March 2020 bottom, should be about 35%,” which would put the S&P at roughly 3,020 (figure below).
It’s worth noting (again) that such levels would be entirely consistent with an earnings decline on par with “normal” recessions and a reasonable multiple.
In other words, Tadesse’s work is yet another piece of evidence to support the contention that stocks need to fall an additional 15% to 20% (give or take) before it’s all priced in, where “all” means valuations have compressed, earnings estimates have come down and the trajectory of the rebound from the pandemic collapse looks more like historical returns following bear market lows.
“If 150 years of history is right, the market should bottom out about between -34% to -40% from the January 2022 top, between 2,900 and 3,150 for the S&P 500 over the next six months,” Tadesse said.
But this time is different đŸ˜‰
What is the percent lower (and in what time frame) that would cause enough companies to fail, hiring (and raises) to stop… such that people and companies buy (bid) less?
Is there a natural post-summer splurge tightening or will this Recession rear more evidently in the biggest consumer spending moment, Q4 holidays?
Reading this, I couldn’t help but conjure up in my mind some yesteryear wholesome actress, like Sally Field, playing somebody’s mom, slapping Jerome Powell on the wrist and saying “Now, just… just… stop messing with it! It’ll be fine. Now, go outside and play!”
A bit too late for that, I suppose, by 20 years or so.
Nice visual! Where is the Flying Nun when we need her?
Stagflation appears to be the most likely outcome – unless Western oil/gas sanctions against Russia (which are harming The West and enriching Russia) are reversed.
With stagflation there is literally nothing the Fed can do to get rid of both of those problems at the same time. I am guessing the scales tip in favor of boosting the economy. Because it is one thing if the poor people storm the Federal Reserve because of inflation, but the Fed is likely even more afraid of the rich people seeking vengeance against the Fed after the Fed destroys their net worth.
back to the data set presented … is the pandemic low a historical bear market in any sense other than numeric? H may be putting a bit of tangerine in the oranges w/ this one but if any merits that stretch, H does. sure glad I’m not a trader.
earnings and CEO commitments to next 2 quarters of earnings will be worth watching (and remembering later – I’m going to write them down)
Buyside probably expects negative 2Q reports/guides, while sellside estimates haven’t caught down.
As always, will be Interesting to see if stocks go up or down on bad news, but with macro data moving rapidly and July FOMC meeting close on the heels of earning season, not clear why reaction to earnings will/should be a big factor in portfolio positioning, even in the short term.
My for-what-its-worth two-cents-bet is “go down”, considering we’ll likely be coming off a quarter-end rebalancing rally and in the heart of the summer doldrums.
Someone with better memory/charting skills can correct me, but I can’t think of (m)any times when SP500 put in a big, durable bottom in the summer months.