What a run!
Stocks have been on fire for the past three weeks and change. The S&P 500 ^GSPC Index is up 24% since March 23.
In a vacuum, that’s an incredible rally - an almost 3,000% annualized return for the index if it kept up over the course of a year.
But since investors don’t operate in a vacuum, a little context is in order.
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The only thing that matches the pace of the rebound we’ve seen over the course of the past few weeks is the speed of the selloff that preceded it. The covid-19-induced crash that began back in February was the fastest selloff from all-time highs on record.
But while the crash is historic, it hasn’t been completely without precedent.
And history suggests some caution is in order for investors who are feeling newly confident following the rebound rally.
To figure out what’s likely to come next for stocks, we’re turning to the data to see what we can glean from statistically similar time frames.
The saying goes that while history doesn’t repeat, it rhymes. And markets in 2020 are certainly rhyming with two prior crash environments: 1929 and 1987.
Those two market regimes are unique in that they were the only other two substantial drops that came suddenly from record highs in the S&P 500 (or its predecessors).
At a glance, it’s not hard to spot the similarities:
To avoid affecting correlations, the chart above factors in the faster speed of 2020’s crash by speeding prior time frames linearly by 1.7 times - critically, the drawdown axis isn’t altered.
While the magnitude of the moves differs, the turning points line up incredibly well – both then and now. Back at the end of March, this relationship suggested we were looking at an intermediate-term bottom. And that’s exactly what’s happened.
More recently, however, things have started to change. The 2020 price action has decoupled from its analogs, as the S&P 500 has slingshotted higher in the past 10 trading sessions or so.
That’s a little concerning because it means we have a little less clarity about what’s likely on deck for the market.
Still, rolling correlations between the two remain very high:
What’s likely causing the shift? The Fed’s unprecedented moves to step in and provide stability to markets from which the central bank has traditionally been absent.
That’s been a boon for investors’ equity values in the past few weeks. But the question is: If the market’s equilibrium state is closer to where it’s stood during other crises, what happens later on, once investors start anticipating a scaleback?
A view of every 25% or worse drawdown in the S&P 500 since 1928 indicates that 2020’s snapback has been unusual. We’re just 16 trading sessions from that selloff point, and yet we’re already looking at the second-best one-year return from the post-plunge:
The bottom line? We're currently at a point in the selloff where things stabilize. But with the spread between 2020 and prior crisis markets now at highs, caution is probably warranted right now.
“Don’t fight the Fed” is still an important axiom to follow in 2020. If you're feeling particularly bearish, rather than betting on another leg lower, a wise move is to follow relative strength and move exposure to investments that are working in this environment – sectors like tech, consumer staples, health care and utilities.
That approach has paid off in spades in prior similar crisis events, and it’s the lowest-risk, highest-reward way to play things from here.