What a difference two months make. Back in June we were drawing grim parallels with 1970. That’s how far back you had to go to find a start to the year as bad as the 20pc fall in the US stock market in the first half of 2022. One or two optimists noted that the Dow Jones index recovered all of its losses in the second half of 1970 and continued rising for another couple of years. But that seemed an unlikely outcome this time in the face of sky-high inflation, rising interest rates and a looming recession.
Well, not for the first time, the market has had other thoughts. Since the middle of June, the S&P 500 has risen by 17pc, retracing half of the losses incurred in the six months from the January peak. The tech-heavy Nasdaq, which led the retreat, has rebounded even more strongly, up 23pc since June. All of a sudden, a re-run of 1970 looks more feasible.
The problem, of course, is that when we look back to 1970 we do so with the benefit of hindsight. We know what happened next. Today, we are guessing what the rest of 2022 will bring. So, how do you tell if what we’ve enjoyed over the past two months is the start of a renewed bull market or just another bear market rally?
With difficulty is the short answer, because we don’t have a crystal ball, and looking backwards can only tell us so much. History rhymes, it rarely repeats, but the past is the only guide we have. So, let’s start by looking at some facts.
First, there’s been a broad-based return to form. In June just 2pc of companies in the S&P 500 were trading above their average price for the previous 20 trading days. Today 93pc of them are. Those are extreme numbers by historical standards; momentum is on our side.
What about the speed of the rally? Unfortunately, there’s not much to see here. If you overlay this year’s rebound on a chart showing all the bull markets of the past 100 years, the current one sits right in the middle of the pack. Trouble is, if you compare it to all the bear market rallies over the same period, it looks quite like them too.
You can make a good case that the market is re-running the early stages of some of the strong bull markets of recent years. But look at the bear markets that started in 2000 and 2008 too and you will see plenty of rallies that looked just like the current one before resuming their downward path. V-shaped rebounds are typical of both early-stage bull markets and bear market rallies.
When it comes to the extent of the rise, we might be onto something more useful. History suggests that bear market rallies rarely claw back more than 50pc of the previous loss. When they go beyond this point, it is usually a sign that the rally is the real deal. So, today’s recovery looks like it might be at a watershed moment. The more the market keeps rising from here the less worried I will be about a reversal.
The change in leadership is a positive signal too. Renewed bull markets are not usually led by the same sectors that led the previous up-cycle. The rally since June has seen a shift from the growth stocks that led the pandemic bull to boring old utilities, energy and dividend paying shares. There’s more to this than investors simply being tempted back into what worked before.
Those are the positives. There are some important notes of caution too. The first is that sentiment has quickly recovered from the abnormally low levels it reached in June. I’d feel more positive if more people still felt negative. Valuations tell a similar story. The rally has pushed earnings multiples back up to levels that don’t feel obviously cheap.
And those valuations are not likely to be rescued by earnings. The results season just finished was not as bad as some feared, but strip out soaring energy profits and the rest of the market is only just moving in the right direction. Earnings are not a drag on the market, but they are not providing much of a tailwind either. Finally, interest rates. Yes, the terminal point of the cycle may be a bit lower than we feared, but the Fed is not finished yet by any stretch.
In short, we don’t know if this is the start of a renewed bull or a bear market rally. And, if you are anything like me, that probably means you have spent the past two months doing little, watching the market rise and getting irritated that another opportunity has passed you by. Well, rather than get cross we should get real. That is how things always are. The way our brains are wired to avoid loss and pain means we will usually miss these short-term trades. We probably shouldn’t even try.
A far better approach to benefiting from the summer rebound would have been to have invested regularly, systematically and without emotion as the market fell through the first six months of the year. Anyone who had done that would have found themselves usefully exposed to the market in June despite, not because of, what they felt about the economic and investment outlook.
When I play golf, I start the round with a plan. I know which club I’m going to use and when. What usually happens is that I have a couple of bad holes, I start to chase my score, try to match the great shot my partner has just played….and reach for my driver. It’s invariably a bad idea, the equivalent of jumping feet first into the market at the top of a bear market rally. Stick to the plan. Eliminate the emotion. Do as I say, not as I play.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
