By Victor Sperandeo with the Curmudgeon Introduction: These are certainly interesting and unique times! In this post, Victor shares his thoughts and opinions on a variety of topics, while the Curmudgeon provides a historical perspective on previous bear markets, bear market rallies with supporting tables courtesy of Goldman Sachs and Bloomberg.
Since 2008, the U.S. federal government and the Federal Reserve Board have been operating under fiscal and monetary models that are designed to avoid a recession at all costs, e.g. a trillion dollar budget deficit accompanied by record low unemployment and ultra-loose monetary policy. The problem with such a model is that it was not designed to survive an unknown shock, such as a pandemic.
To clearly illustrate this point, Janet Yellen, Former Chairperson of the U.S. Federal Reserve said (after reviewing the results of a stress test in 2017):
“Would I say there will never, ever be another financial crisis? Probably that would be going too far. But I do think we're much safer, and I hope that it will not be in our lifetimes, and I don't believe it will be.”
To be accurate, Ms. Yellen said financial crisis rather than recession. Yet if the federal government and the Federal Reserve had not thrown an “atom bomb” at the coronavirus it would be a financial crisis, as well as an economic Armageddon.
Unprecedented Fiscal and Monetary Stimulus (Victor):
To date, the U.S. government has authorized the spending of $2.25 trillion in “stimulus,” a.k.a. bailouts and giveaways, as well as $4 trillion in loans (which are really grants to corporations on a need basis). That is in addition to increasing the Federal Reserve’s balance sheet to perhaps $10 trillion with “QE infinity.” For sure, this was only the first few salvos to be fired; there are other multi-trillion-dollar spending proposals being discussed.
Deflation Ahead (Victor):
It’s important to note that this virus has caused a deflationary problem, which I expect to persist over an intermediate time period. Although gold was up 3.6% year-to-date as of March 31st (primarily as a “risk off” or perceived “safe haven” trade), the CRB Commodity Index is now trading at February 1999 levels! Trading at less than 1% nominal yield, the 10- and 30-year U.S. treasuries are also discounting deflation dead ahead.
For years equities have been the darling of the rich, the government, and the Federal Reserve, while commodities have been the black sheep of the financial community. Now they’re both in the tank!
Bear Market Intact (Victor):
This is an equity bear market in the classic sense, and it likely hasn’t ended after 33 days. (See Curmudgeon comments on what type of bear market it might be and a history of bear market rallies).
What would be typical is for the popular stock market averages to make an intermediate low in mid-April, into the poor earnings season and 2nd quarter guidance horror show. Then we could see a rally of between 33% and 66% of the first leg down, before making new lows or major bottom later in the year.
However, it is critical to recognize that past performance is never necessarily indicative of future results, especially as the current market is far from typical as are the factors currently influencing it.
Perspective on the U.S. Economy (Victor):
The 11 year economic recovery, which has clearly just ended, will be classified to be at least 126 months long by the National Bureau of Economic Research (NBER). That’s the longest recovery in U.S. history.
After the virus pandemic ends, many pundits are talking up a “V Bottom” type of economic recovery. In my opinion, that talk is very premature and highly unlikely.
In March 1933, the highest unemployment rate in U.S. history was recorded at 24.9%. Yet in December 1936 it was still 19.97%! FDR threw the kitchen sink at the economy. In addition, prohibition ended, and with the passing of the 21st Amendment in 1933 tens of thousands of bars and restaurants with hundreds of thousands of new jobs were created, yet in 3¾ years the unemployment rate dropped only 5%.
I do not believe the U.S. economy will experience a “V bottom” when so many bad experiences are taking place. Human nature calls for fear and caution to very slowly move back to normal spending. With 70% of the economy based on the consumer, does anyone believe that people are going to go back to pre-pandemic spending ways in just four months? I think not.
With respect to politics, President Trump is letting his wishes dictate his statements. According to the Wall Street Journal, Washington Post, and NY Times Trump has ignored the advice of his medical and health experts, which has considerably slowed the U.S. response to the coronavirus. That will surely have a negative economic impact.
Curmudgeon on Bear Markets:
Every bear market has a unique set of drivers, but throughout history most of them fall into one of four categories:
· Structural – These are the result of financial bubbles, too much leverage, credit market dislocations, and other structural imbalances. Examples are the February 2000 to March 2003 and early 2008 to March 2009 downturns, which each produced -50% declines in popular stock market averages.
· Cyclical – Cyclical bear markets happen more as a function of the business cycle, when growth leads to inflation, interest rates go up too fast, the yield curve flattens or inverts, loan activity declines, demand wanes, the economy is in recession.
· Event-Driven – These bear markets are triggered by an exogenous event, like an energy crisis, political instability, war, or in the case of the current bear market, a global pandemic.
· Secular – This type of bear market lasts for at least a decade and is usually accompanied by one or more intermediate cyclical bull markets. However, the major trend is one of wealth destruction as the real purchasing power of stocks decline over many years. Dollar cost averaging doesn’t work and time is your enemy for an equity investor that wants to retain purchasing power (don’t we all?).
The most recent secular bear market was 1966 through 1982, which saw good rallies from December 1974 through 1978 and then again from March 1980 through the summer of 1981. It was a very painful and frustrating period for the Curmudgeon.
Looking back at data going back to the 1800’s, Table 1. shows the relative magnitude and duration for the first three types of bear markets:
Table 1. Characteristics of three types of bear markets:
Source: Goldman Sachs
Zacks’ Mitch on the Markets wrote in an email to the Curmudgeon:
It’s important to acknowledge that there has not been an event-driven bear market in history that was triggered by a virus/disease outbreak. I think it’s important to hold out the possibility that this event-driven bear could morph into a structural (or even secular) bear market if the crisis is not contained by, say, summer. In the meantime, however, I think the sheer size and speed of fiscal ($2 trillion legislation) and monetary (virtually infinite liquidity) stimulus should help keep this bear market in the event-driven category for a few months.
Curmudgeon on Bear Market Rallies:
Since the end of 1927, the index that ultimately became the S&P 500 has experienced 14 separate bear markets, according to Bloomberg calculations that define them as beginning any time the index closes more than 20% below a record peak. Assuming a bear market continues until the index either doubles from a post-peak low or climbs above its pre-bear market high, the average bear market duration was 641 days.
Within those periods, the S&P 500 has rallied more than 15% on 20 separate occasions (see Table 2. below) before retracing those gains. Those advances lasted about 78 days each. But even some of the retracements were marked with up moves in the market, underscoring how hard it is to determine the MAJOR TREND in a typical bear market.
Table 2. S&P 500 Advances of over 15% during Major Bear Markets:
Source: Bloomberg ……………………………………………………………………….
Conclusions (Curmudgeon and Victor agree):
No one knows how long this bear market will last. It all depends on how effective the world is in containing the coronavirus and getting people back to work. Therefore, don’t believe any of the forecasts you might read or hear about, especially the so called “V shaped” economic bottom and recovery.
No end quotes today (we’ve said enough already)!
Good luck, stay safe and healthy. Till next time...
The Curmudgeon, email@example.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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