Where is the stock market, and where is it headed? We’ve rallied 10.5% since the lows of Christmas Eve, but investors are still nervous about what’s next. While no one can predict the future, we can use the past as a guide that may offer some clues about the coming year or two.
The S&P 500 dropped 20% from September 20th to Dec 24th of 2018. On a closing basis, it fell 19.8% to be exact. But we did have a tumble of 20% at one point, which took us beyond correction territory into a bear market.
Investors’ confusion about where we are in this market cycle is understandable. We experienced a huge pullback, and then a rally, and now, perhaps a pause. The question on everyone’s mind is whether we’re finally out of the woods. The answer, as always, is layered. Let’s answer it using historical data and trends as a guide.
There are two types of bear markets: those with a recession and those without a recession. And, we look at bears in the context of larger cycles, like whether, during a long-term bull market, the bears and corrections we experience are just turbulence along the way. It appears we are currently experiencing a long-term bull (the overall ten- to twenty-year trend is up). We are seeing a baby bear rearing its head during an on-going bull market.
In these situations, it’s not unusual to experience corrections and bears as we’ve seen. Similarly, it’s typical to see rallies to the tune of 15% during bear markets. Since we can’t see ahead, the best way to get a sense of where the market might be headed is to look backward.
My firm and I looked at all cyclical bear markets since 1903 to garner some insight. We wanted specifically to understand how markets played out historically when there was a bad market in an otherwise solid, long-term, multi-year good market – situations similar to what we believe we’re currently experiencing.
Here’s what we uncovered.
Peak to Trough – It takes nine months on average to hit a market bottom. It’s not uncommon to rally 10% or more, then re-test the lows, or even post a new low before we go from peak to trough. Currently, we’re about four months into that cycle. Now, it is possible that we’ve already bottomed out during the week of Christmas. But it’s also feasible that we could see the market re-test the lows and flounder over the next several months before putting in a bottom. Still, the data since 1903 show the average decline is 21.8% — a number we’ve already hit.
Trough Back to Peak – It takes approximately 11 months for the market to get back to the original peak during times like these. So, the entire cycle takes time – a total of about 20 months, a little over a year and a half. If we use history as a guide, the bottom should occur around late Spring (May or so). After that, we may well be in a sustainable rally path. If this “healing process” does take that long, then it makes sense that we would have these upward, 10% to 15% moves in the meantime, only to slide down again for a period.
Talking History – History is, of course, history. We can only recognize a true bottom when we see it in the rearview mirror. As an example, on March 16th, 2009, even though the market had rallied about 11% in a week, we couldn’t definitively say that March 9th had been the bottom. Sure, we know now. But then, there was no way to really know.
Advance/Decline – What we can be sure of is that there has been a massive shift in buying and selling activity. The Advance/Decline line basically compares the number of stocks that closed higher against the number that closed lower than their previous day’s closing prices. This measure, over a 10-day period leading to the climactic selling on Christmas Eve, 2018, was minus 2,440. This selloff was the worst we’ve seen since 2011. But, over the following 10 days, the Advance/Decline line rocketed to positive 1938. That’s a 4378-point swing.
This whipsaw was one of the largest and most severe shifts we’ve seen in 30 years and was similar to a reading back in December of 2008, which was very close to the bottom-out of early 2009.
I’m not calling an all-clear signal yet on this market. As we discussed above, bottoms usually take nine months, and we’re at four. But, a move like we’ve seen over the past few weeks certainly shows signs of strength.
China and the Fed – Two of the most significant swing items that we covered in our 2019 Outlook were the topics of trade with China and the Federal Reserve’s approach to interest rates. Over the past two weeks, we’ve gotten some reprieve from both fronts. News reports indicate that the US and China are actually talking, not at a stalemate. This is a sign of progress.
Federal Reserve Chairman Jerome Powell and the Fed board understand they scared markets back in December and have made a concerted effort to let markets know they will be careful and prudent about raising interest rates. Markets tend to love low, stable rates.
Bottom Line – I can’t say we are off to the races with stocks, but I remain realistically optimistic. We are, after all, heading into earnings season, and the numbers (whatever they may be) typically have a huge impact on the markets’ near-term performance.
So, despite market action that has signaled a shift in sentiment from negative to positive, history tells us that the bottoming-out process may not have run its course. Of course, we could be an anomaly to the data, but I’m not so sure. Only time will tell.
