A Historical Perspective on Bear Market Rallies
August 19, 2022
After a significant pullback this year, we’ve seen a strong month of returns for our portfolio companies and for the S&P500. Today we want to share a historical perspective on rallies during down markets (so called ‘Bear Market Rallies’) and evaluate the situation equity markets are facing.
In summary, bear market rallies are not historically uncommon during periods of contraction. While fundamentals remain relatively solid and have surprised to the upside recently, we believe that the key challenges facing equity markets are yet to be properly addressed. Until the challenges facing markets today are properly addressed, we expect ongoing volatility in equity markets. As a result, we continue to maintain balanced portfolios with a defensive tilt and a focus on quality investments with steady cash flows.
Why has the market staged a relief rally?
The rally in stocks over the last month and a half has been driven by three primary factors. Firstly, the second quarter earnings season was better than expected. The majority of companies beat expectations, which eased fears of a sharp earnings slowdown and drove stocks higher.
Secondly, there are signs that the rate of inflation may have started to slow (mostly because of lower commodity prices). This is positive for the consumer and the federal reserve as it may slightly ease pressure on them to increase interest rates.
Thirdly, investor sentiment has improved as a result of better than expected earnings and a slowdown in inflation.
What are the two main challenges haven’t been properly addressed yet?
Inflation: While the moderation in inflation has been positive for our portfolios, CPI at 8.5% remains a long way off the fed’s target of 2%. As a result, we believe that the fed still has a lot of work to do to bring inflation down closer to target (they do this by raising interest rates).
The unemployment rate is at historical lows and is contributing to inflation, which puts additional pressure on the federal reserve to raise interest rates. Until the challenge of bringing inflation down is properly addressed by the fed, we expect pressure on interest rates and further volatility in markets.
Economic growth: Two consecutive quarters of negative GDP growth has preceded the declaration of a recession all but once (in 1947). While a number of economic indicators remain solid, we are seeing signs of consumer weakness from some portfolio companies and with interest rates going up, we think that the challenge of slowing economic growth is yet to be properly addressed. It is entirely possible that strong employment and a strong consumer will drive economic growth from here, but for now we believe it is too early to discount the possibility of a further slowdown.
A historical perspective on bear market rallies
Bear markets rallies are not historically uncommon during pullbacks. There were three around 2000, two around 2008, and many smaller bear rallies through both periods. Between 2000 and 2002, there were bear rallies from trough to peak of 21%, 25% and 18%. These rallies lasted approximately 61 days, 108 days and 29 days respectively. Between 2007 and 2009, there were bear rallies from trough to peak of 15% and 27%, lasting for 63 days and 47 days respectively. Going back as far as 1973, there was a bear rally of 13% from trough to peak, which lasted 51 days.
Bear market rallies – a historical perspective from 2000
The common theme we found in prior bear rallies is that the rallies were driven by premature hope that underlying challenges facing the economy and markets at the time had been addressed.
Where are we today?
By way of comparison, today’s market has rallied ~14% from peak to trough and the rally has lasted around 46 trading days. We hope for a continued slowdown in inflation and for strength in the economy, which is positive for our portfolios and could continue driving equities higher. However, based on history and the challenges facing the stock market today, the possibility that we are in a bear rally cannot be discounted yet.
Until the challenges of bringing inflation down and growing the economy through uncertainty are properly overcome, we believe it is prudent to maintain a balanced portfolio with a defensive tilt. In the meantime, we continue to focus on quality investments with steady cash flows, with the confidence that after almost every pullback, recoveries have been much stronger.
Bull markets (blue) vs bear markets (orange) through history
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