An impressive rally has been underway for the past few days, bringing gains to +26% from the March 23, 2020 lows. But given the uncertainty around the duration and magnitude of the economic fallout and inconclusive healthcare crisis visibility, it is natural for most of our clients to be wary.
So the question we would like to address, is what level does the S&P 500 need to reach to confirm a bottom is in place?
The simple way to answer this, is to look at the declines of 1987, 2002-2003 and 2008-2009 and ask, where did the “false bottom rally” fail?
– Nov 1987 failed at 33% retrace
– Sep 2002 failed at 33% retrace
– Dec 2008 failed at 24% retrace
The upper threshold is a 33% retrace.
In the current S&P 500 today, 33% ~2,600. 24% is 2,475. The S&P is at 2,712.98
– So the S&P 500 has moved beyond the upper ranges of the crashes of 1987, 2002-2003 and 2008-2009.
Figure: 2020 S&P 500 plus the retrace rallies of other failed bottoms marked.
POINT #1: 50% retrace is conclusive of the bottom is in…But how do we know if the bottom is actually in? We think the simplest rule of thumb is retracing 50% of the losses. Below, we show when the 50% retrace was reached:
– Post 1987, it was Sept 1988
– Post 2002, it was Dec 2003
– Post 2008, it was Dec 2009
Notice the pattern?
Well into recovery, a 50% retrace confirms the low. Thus, the S&P 500 2,793 is a key level. That is ~100 points above here. So we have not breached that level.
Figure: 1987 bottom, failed rally and confirmed recovery
Figure: 2002-2003
bottom, failed rally and confirmed recovery
Figure: 2008 failed rally and confirmed recovery
POINT #2: Symmetry in market declines, the faster the decline, the faster the recovery…
We are going to highlight again an interesting symmetry in markets. The speed of the decline governs the speed of recovery to 50% of the losses and the speed of a full recovery. We think investors are underestimating how quickly stocks will recover.
– This symmetry is key. Half of the losses should be recovered within 0.5X of the time. We fell over 6 weeks, thus, a recovery to 2,800 should only take 3 weeks.
– The last 3 major declines of >30% are shown below. And you see the symmetry.
– This implies 2,800 by mid-April (if 3/23/2020 was low) and full recovery in equity markets by 3Q2020.
Yup. We realize this counter to intuition. Intuitively, breakdowns take time to recover. But history says this time for recovery is symmetric to the speed of decline. The faster the decline, the faster the recovery. It sounds strange, we agree.
Looking at the 10 declines since 1920 of >30%, this symmetry still holds. The median time to new highs is 2.5X the speed of the decline. Basically, equities are like rubber bands.
Shown below, the implied date for a new high, contingent on an early April peak of US cases, is mid-2020.
STRATEGY: HOW CAN THIS BE WHEN THE DEPRESSION/RECESSION IS IN FRONT OF US?
We think this remains the mystery. Why are stocks recovering so quickly, if the recession has yet to start.
The biggest mistake I make is when I try to “tell the market what to do” because the collective wisdom of markets is ultimately somewhat forward-looking.
We can cite 5 reasons this could be happening. None is our baseline, but the recovery in stocks could be telling us:
– Healthcare crisis peaks fast enough to avoid massive destruction of the global economy
– Consumers will be way more resilient, so the recovery is V-shaped vs consensus L- or something worse
– Fiscal policy was fast enough to stave off a deeper contraction
– Fed has moved quickly enough to stave off a deeper financial market crisis
– Stocks over-reacted to the pandemic
The key level is 50% retrace at 2,793. If we breach this, the recovery is likely well underway.
Remember market symmetry.
