A pedestrian wearing a face mask looks at a smartphone while passing in front of the New York Stock Exchange (NYSE) in New York, on Monday, July 20, 2020.
Michael Nagle | Bloomberg | Getty Images
At a certain point in the wee hours, it’s both late and early.
For those who’ve been partying hard, dawn is a signal things have gone far enough – or maybe too far. Among those who’ve been lying low, sunrise is a fresh start, offering the chance to get things done.
Which brings us to the current stock-market setup.
The S&P 500 is up 50% over 100 trading days, taking it to the edge of a record high, making this rally the strongest in history and, by some interpretations, ending the shortest bear market ever. Based on some tactical, calendar and sentiment indicators, this powerful rebound is looking mature and prone to slow down or slip back in the short term.
Yet the angle and speed of the market’s ascent also make it resemble most closely the powerful moves off decisive and sanctified market bottoms of yore, ones that kicked off long bull markets and signaled enduring economic revivals to come. What to make of those?
Hesitation Near the Highs
The market’s difficulty last week in pushing above the February S&P 500 closing peak level of 3386, despite a few game attempts, is partly explainable by the numbers alone. If nothing else, the tape has had to absorb whatever mechanical selling came its way from traders locking in the break-even level and profit-takers using it as a target and device not to get too greedy.
Yet the market comes to this point just as professional investors are showing more optimism and aggressiveness in playing the upside than we’ve seen since before the Covid-shutdown crash. Rampant buying of upside options bets has the put-call ratio stretched near multi-year lows.
The equity exposure level of the tactical money managers tracked by the National Association of Active Investment Managers clicked above 100, a very elevated reading suggesting performance-geared pros are roughly all-in.
Retail investors have been less willing to trust this comeback rally in the face of severe economic stress, yet even here, a nearly $5 billion net inflow into domestic equity funds at last report was the highest in nine weeks.
Coming just as Apple ran to the cusp of a $2 trillion market capitalization and Tesla soared anew on the fundamentally substance-free announcement of a 5-for-1 stock split, it all suggests an emerging complacency that could make further easy upside difficult and leaving the broad market ill-positioned for any adverse surprise.
Resembles past significant bottoms
Yet from a broader angle, the market action — accompanied by an improving cadence of most economic measures — places the past few months in close alignment with some storied market revivals of the past.
Here the S&P since the March 23 low is set against the strong rallies off the 1982 and 2009 bottoms, and the resemblance is hard to discount.
Even if the comparison has merit, the pattern shows this rally is running ahead of those prior instances, so no one should be shocked if progress stalls or the S&P corrects a bit soon.
But there’s a debate worth having over whether these historical instances are good precedents for today. The five-week, 34% collapse in the S&P 500 was less a classic bear market than an event-driven crash.
The sharpness and speed of the downturn — and the immediacy of the overwhelming liquidity and fiscal response from the Federal Reserve and Congress — forestalled the kind of grinding, purgative action of typical bear markets, which wrings out excesses and resets valuations lower. There was also not the shift in market leadership that usually occurs in the crucible of a bear market.
And, perhaps crucially, not much of the prior bull market’s gains were disgorged.
As this chart from SunTrust’s Keith Lerner shows, prior generational market lows – ones that launched long-lasting bull markets – came when the trailing 10-year annual returns for the S&P 500 were depressed. At the August 1982 bottom, the prior decade had delivered annual total returns below 3% over the prior decade; on 2009 it was -4.5%. On March 23 of this year, the S&P was still up 9& annualized since March 2010 – around the average long-term gain.
This could make the latest episode a bit more like the 1987 crash – a dramatic and traumatizing jolt after years of strong gains.
The losses from the ’87 break were relatively quickly recouped (though far less quickly than this year’s). That was the moment that the Fed began conditioning investors that it would rescue markets. And stocks did pretty well over the next couple of years before hitting another mild bear phase, before resuming a nice uptrend – just not as strong as from ’82 or ’09. (The recent comeback also tracks pretty closely with the ultimately doomed rebound from the 1929 crash, incidentally – a less hopeful parallel.)
This discussion is mostly about setting short- and long-term expectations, not a means of handicapping the outlook in any precise way.
Even if the rally arguably appears slightly ahead of itself, the underlying message of the tape is encouraging. The market has helpfully broadened out lately beyond huge growth stocks toward cyclical areas like global industrials, transportation stocks and housing-related names. The S&P has deflected negative seasonal tendencies in August so far. Corporate credit has performed extremely well, with compressed borrowing costs supporting equities.
And while professional investors and a new cohort of novice stay-at-home traders are edging toward overconfidence, markets can certainly trend higher for a bit even while the in-crowd is showing swagger. And the Wall Street establishment and core retail investors are relatively cautious, a partial offset.
And what if the market’s strength is a reaction to governing authorities having modeled a way to short-circuit adverse economic feedback loops, cushion against disorderly default cycles and demonstrate the effectiveness and massive capacity for aggressive fiscal support? How many P/E points is that worth on the S&P 500 if investors can count on that kind of protection in the future?
So while most of the fun has probably been had in the short term, and the push toward a new high might initially represent a moment of culmination rather than continuation, investors shouldn’t dismiss the chance that it’s not so late in the grand scheme.