Summary : Still, markets are animated by unchanging human nature driving crowd psychology interacting with repeating business cycles. So historical rhythms are much of what market handicappers have to work with. Aside from the early-21 st century template, skeptics right now are noting that fast Fed tightening cycles tend to keep equities under pressure and S & P 500 valuations have bobbed back up above 17.5 times forward earnings from a brief stay below 16. (Isn’t everyone aware that years ending in “2” have featured plenty of significant market reversals?)
There has been nothing routine about the current economic and market cycle. Since Covid-19 first emerged, we’ve witnessed the quickest 30% stock-market drop ever, the briefest recession, the most aggressive fiscal and monetary response, the fastest doubling of the S & P 500 from a bear-market low in history, the highest inflation in decades, the most forceful Federal Reserve tightening moves in a generation and the worst first half of a year for equities in half a century. Given all these superlatives and rarities in the recent past, historical patterns might not seem to offer much useful wisdom about how things might go from here, as a resilient stock market and still-healthy employment picture vie with a resolute Fed and deeply inverted Treasury yield curve for investors’ attention. Still, markets are animated by unchanging human nature driving crowd psychology interacting with repeating business cycles. So historical rhythms are much of what market handicappers have to work with. And bears and bulls alike have their preferred precedents. The 2000-2003 bear Those most skeptical of this rally are keeping the turn-of-the-millennium bear phase foremost in their analysis. This was the unwind of an exuberant, overvalued technology-centric equity market coinciding with a relatively shallow economic recession but one that triggered a nasty reckoning within Corporate America. The Fed was raising interest rates consistently in 2000 to restrain inflation in a fully employed economy, a similar but less-dramatic version of the current arrangement. On a tactical level, technical analysts are noting the pattern of very strong bear-market rallies that erupted along the way during the S & P 500’s long slide to a near-50% decline by early 2003, which ultimately offered false hope that they represented a genuine bottom. A strong rebound in early 2001, after the S & P 500 had fallen more than 25% from its March 2000 peak, gained more than 20% and recovered almost exactly half of the total index losses to that point, before rolling over to make new lows by that September. The technicians have generally been on the right side of the market in recent months, their approach of respecting the prevailing trend above all else keeping them cautious and quick to recommend selling into relief rallies. Chris Verrone of Strategas took a detailed look at the strong but ultimately doomed 2001 rally to say it lacked the kind of momentum push and sentiment shift that would turn the trend bullish, and sees the current rally in a similar light . Jonathan Krinsky at BTIG pointed out that any rally that regains more than half of the total decline on a closing basis tends to mean a bear market has likely ended . In the current setup, this would mean the S & P climbing another 2-3% above 4,230, a nearby test of the bear’s resolve. In detail, today’s conditions don’t match perfectly with those of 2000-2003, of course. Stocks this time never got quite as expensive and were sitting on less-heady longer-term gains at the peak. Right now, seven months into this market retrenchment, the trailing total annual return for the S & P 500 over the past five-, 10- and 20 years are 12.6%, 13.6% and 10.5%. Those are pretty healthy gains, and investors should recognize the market has been good to them even after this rough patch. After a similar amount of time following the peak in 2000, the S & P had delivered 21%, 19% and 17% a year over the prior five-, 10- and 20 years, making the reversion-to-the-mean forces that much stronger. Aside from the early-21 st century template, skeptics right now are noting that fast Fed tightening cycles tend to keep equities under pressure and S & P 500 valuations have bobbed back up above 17.5 times forward earnings from a brief stay below 16. While the equal-weighted S & P’s forward P/E remains below 16 (huge-cap stocks are inflating the index multiple), it’s tough to argue the market is exactly cheap. The 2010s experience A more upbeat take views the current economy as undergoing nothing more than a deceleration and a growth scare, but without the accumulated excesses in corporate or consumer leverage and recklessness that would drive a nasty downturn. In the year 2010, the economy was seen as fragile only a year or so after emerging from a traumatic shock. Stocks were disgorging a chunk of their fast gains off the market bottom and investors generally believed the Fed was cornered and would have to accept serious damage to the economy and corporate profitability to escape its predicament (deflation then, inflation now). It was also a midterm election year with an unpopular first-term Democratic president facing an adverse swing in Congressional makeup. That year, with investor worry flaring about systemic shocks in European economies, the S & P 500 tumbled 17% from a January peak to a June low before recovering, first in a sideways range until the fall and then with a strong upward push. The appeal of this precedent to the bulls right now should be pretty clear, given the similar rhythms of the 2022 tape so far. Ned Davis Research maintains a “cycle composite” chart for each year, combining the annual seasonal market pattern, the four-year election cycle and the 10-year “decadal” tendency. (Isn’t everyone aware that years ending in “2” have featured plenty of significant market reversals?) So far this year’s path is generally following the cadence of this cycle composite – in direction and timing if not in magnitude. For what it’s worth, this framework fits with a June market low for 2022. For separate reasons, Ned Davis chief U.S. strategist Ed Clissold shifted 5% of his model portfolio into stocks from cash, taking equities to a target market weight, largely based on some breadth signals triggered in the ramp off the mid-June low, noting on Tuesday, “The risk that the recent advance is merely a bear market rally has not been eliminated. But…the technical improvement up to this point is more akin to a new cyclical bull market than a bear market rally.” Such inflection points are only clear in retrospect, of course. But the June low featured some rare extremes showing a washed-out market of a sort that has typically meant a very high probability that the S & P would be higher in 12 months’ time. And companies that missed earnings forecasts this quarter have seen their stocks hold up better than in just about any quarter on record, a decent sign that the market had priced in a good deal of bad news. The index is now, of course, some 13% higher already from June’s oversold low, so this doesn’t mean the market is headed straight up from here, by any means. Still, the tape’s ability to get traction Friday after a quick reflex selloff on the very strong monthly jobs report suggests that a broad economic downturn isn’t a forgone conclusion, and implies that the recent rebound was not entirely about hopes for a more dovish Fed but also the plausibility of a soft economic landing.