After gradually rising to record highs in the year’s first six weeks, markets plunged—rapidly adjusting to the growing likelihood business disruptions from coronavirus containment efforts will produce a global recession. Usually, bear markets develop slowly as recession probabilities grow. Not this time. It took just 21 days for global stocks to reach bear market territory (-20% or more from a prior high), making this history’s fastest-developing bear market by far. While the speed is unusual, investors’ reaction has been fairly typical: For many, their confidence is shaken. They question how a recovery may look. While no one knows when it will come, the very speed and power of the panic suggests to Fisher Investments it will look as market recoveries usually do: Steep, sharp and near-totally unexpected, surprising many by forming a “V”-shape on a chart.
Most blame the plunge on the coronavirus’s global spread, which we think is partly correct. In Fisher Investments’ view, though, the downturn’s proximate cause is less the pandemic’s human toll—although that is unquestionably tragic. Rather, stocks’ reaction seems tied much more to society’s response to the coronavirus outbreak.
A spectrum of organizations—corporations, regional and national governments, non-governmental institutions—have reacted to the virus by enacting sweeping restrictions on business. These interruptions slammed the brakes on an economic expansion. Markets usually move well ahead of cyclical shifts in the economy (from growth to contraction, and vice versa). Bear markets ordinarily start gradually, pricing in mounting evidence of an approaching recession. But this time, the shock interruption to business forced them to suddenly price in a far higher probability of a recession than anyone thought likely before. These features are unique—but recessions and bear markets aren’t. According to Fisher Investments’ research, they nearly always end with stocks climbing steeply, forming a “V” on a chart. After 6, 12 and 18 months, stocks are usually far, far higher.
Exhibit 1 plots S&P 500 price returns 6, 12 and 18 months from S&P 500 bear market troughs since 1926, when reliable data begin. As you can see, bull markets typically begin with a sharp jump.
Exhibit 1: Bull Markets Begin With Big Bounce Backs
Source: FactSet, as of 3/19/2020. S&P 500 price returns 6, 12 and 18 months from bear market lows, 1/3/1926 – 3/19/2020.
Beyond the shock interruption to business, we think some structural market factors help explain the extreme volatility we have seen since late February. Post-2008 regulatory changes intended to strengthen the financial system also required banks’ proprietary trading desks to stay mostly neutral. That limited their ability to fulfill their traditional role as market makers—sources that would take the buy side of trades in a panic. That means less liquidity during periods of extreme stress, like the present. High-frequency traders could pick up the slack, but they are programmed to avoid risk and target a neutral position as well. The upshot of this, in Fisher Investment’s view, is that markets are less liquid. Bid/ask spreads—the difference between what buyers are willing to pay and sellers are willing to sell for—were extraordinarily wide throughout much of March. That exacerbates price swings dramatically. Algorithmic trading compounds matters, in our view, as many respond to the same signals and flood the market with sell orders.
We don’t know when this bear market will end. In Fisher Investments’ view, it largely depends on when the coronavirus fades and restrictions on business lift. Regardless, though, it will end eventually. When it does, Fisher Investments believes the rebound will likely be much like the past: Swift, and surprising to most.
The reason: Stocks regularly rebound before recessions end. Bear market troughs typically feature extreme pessimism as panicked investors depress stocks to irrationally low levels. When reality exceeds rock-bottom expectations, the positive surprise often spurs a sharp bounce, forming the right side of a “V.” This typically arrives long before a recession’s end is apparent.
Hence, waiting for clarity can be costly. Not only do stocks generally lead the economy, but data hit at a lag. Whenever the economy starts experiencing green shoots, the data won’t show it for a month or more. As Exhibit 2 shows, the last bear market ended in March 2009. The National Bureau of Economic Research (NBER)—the official arbiter of US recessions—puts the recession’s end at June 2009—an announcement they made on September 20, 2010.[i] Between March 9, 2009 and June 30, 2009, the S&P 500 rose 36.9%.[ii] By the time NBER officially declared the recession over, US stocks were up 74.5%.[iii] Similarly, 1990 – 1991’s recession ended in March 1991, an announcement NBER made on December 22, 1992.[iv] Yet stocks bottomed the preceding fall, on October 11. Between the bear’s low and the recession’s trough, the S&P 500 rose 29.1%.[v] Between then and the NBER announcement, they soared 59.9%.[vi] This holds true even in the absence of stimulus, as the eurozone’s recovery from its 2011 – 2013 recession shows. (Exhibit 3)
Exhibit 2: S&P 500 in 2009
Exhibit 3: Eurozone Stocks
Source: FactSet, as of 3/18/2020. S&P 500 Total Return Index Level, 12/31/2008 – 12/31/2009. MSCI EMU Index level with net dividends, 12/31/2011 – 12/31/2013.
Despite this bear market’s unique aspects, Fisher Investments believes the basic force driving stock movements—the gap between sentiment and reality—hasn’t changed. Whenever sentiment overshoots, we think a new bull market will begin with a bang.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[ii] Source: FactSet, as of 3/19/2020. S&P 500 total return, 3/9/2009 – 6/30/2009.
[iii] Ibid. S&P 500 total return, 3/9/2009 – 9/20/2010.
[v] Source: FactSet, as of 3/19/2020. S&P 500 total return, 10/11/1990 – 3/31/1991.
[vi] Ibid. S&P 500 total return, 10/11/1990 – 12/22/1992.