As the market has fairly consistently risen since March 23rd, some investors feel that this recession led bear market is different than others, and that we have already seen the market bottom. Model Capital Management, one of the Portfolio Strategists we utilize for client accounts, disagrees. Following are some notes from their commentary from their May 15 update written by Roman Chuyan, CFA…
At the March 23rd low point, the S&P 500 closed down 30% for the year to date. The index has since rebounded by a remarkable 28.4%, paring its year-to-date loss to only 10.7%, and now returned to a positive in 12-month performance. The rebound is fueled by optimism about the Fed’s stimulus and the impending economic reopening. However, the US economy has entered a severe recession, and we don’t yet know if March 23rd was the bottom or a protracted bear market has begun.
The US economy has entered a recession, likely the most severe in 74 years, since 1946. Corporate earnings dropped by 13.8% in the first quarter and are expected to be worse this quarter. In two months, 22% of the entire US labor force claimed jobless benefits, and the unemployment rate shot up to 14.7%. Unemployment is already its highest since modern records began in 1948, and it is projected to reach 20% – its highest since the Great Depression. Both retail sales and industrial production slumped last month by the most in 74 years . A 10% cumulative peak-to-trough GDP contraction is expected this year, which would be 2.5 times the size of the 2007-09 Great Recession when GDP contracted by a cumulative 4%.
After commenting that Model expects the market to be down almost 15% in the next month, Roman writes…
It is true that the stock market isn’t the economy – the market looks forward. But future earnings and the economy are unknown. That’s why the market oscillates widely in a bipolar fashion. When financial experts say that negative fundamentals are “priced in” and point to positive 2021 earnings or economic projections, all they’re really saying is, “The market’s up.” Sometimes the market’s “view” of the future is depressed, and other times it’s euphoric. The market being down only 10% YTD and positive in 12 months is euphoric, inconsistent with an economy in a recession more severe than in 2007-09 (when the S&P 500 dropped by 50%). Yes, the Fed went all-out to bridge the economy, but spending and production are down by the most in 74 years in April including the Fed’s stimulus. When it seems too good to be true, it usually is. Our equity model’s latest -15% forecast for the S&P 500 is a fair warning – this may be the final opportunity to reduce risk exposures.
Bear markets coincide with economic recessions, and the two reinforce each other. A severe recession has only begun, which also suggests that a bear market has only begun. In the recent article “What Prior Market Crashes Can Teach Us About Navigating the Current One”, Morningstar’s Dr. Kaplan details how severe bear markets “had an average of 57 months [before] the market hit its trough and a 57% decline.”
Counter-trend rallies are common in bear markets. Our comparison of the current 2020 market (the orange line) to early stages of the past four severe bear markets (1929, 1937, 2008, and the Nikkei-225 in 1990) shows that the initial plunge in March was steeper than average (similar to 2008), and its April rebound was stronger than average (similar to the Nikkei in 1990). So, this year’s market action was more volatile – or more bipolar – than the average of past severe bear markets, represented roughly by the Dow in 1937 (the blue line). This might be due to much higher liquidity and trading than in the past. Note that the Nikkei’s path, which the S&P 500 currently tracks, reverted to -37% six months from its peak. That bear market then continued for 30 years and hasn’t reclaimed its 1990 peak to this day.
It is clear at this point that Model Capital Management sees this recession as the most severe in quite a long time and though it is not certain, they consider it more likely that stocks will not continue to rise but follow the typical bear market recession and fall again over the next 6 months.