Can We Really Believe This Market Rally?

An April 17^th newsletter should, in normal times after a big rebound in the stock market, call for an analogy to the arrival of spring, the beginning of the baseball season and all the joys of attendant hope. Yet outside my window sits a few inches of snow. Baseball may or may not becoming this year. And while the market recovery seems promising, hope feels just a bit out of reach. Maybe it has come from being confined to the house for too long, or reading too much online news, but I find my level of cynicism to be rising in direct proportion with the stock market as it rallies absent any real sign of positive news. That is if you don’t consider massive job losses and exploding personal and government debt to be positive economic indicators.

Occasionally, during an intercession of rationality, I try to convince myself that my intuitions are biased. That my intuitions are made with either incomplete or filtered information. But it is hard not to give in to the “Dark Side” and let my cynical nature drive the car. Yet, even rationally, reasons exist to remain skeptical of the impressive rally we’ve witnessed over the past month. To override my intuitive flaws of filtering and selecting information which only seek to confirm my pre-existing opinion, I usually turn to historical look-backs. Absent a crystal ball to see into the future I look to the past to see how previous examples played out. Here’s what I found:

To start my study I looked back at previous periods in which the S&P 500 rallied over 15% in a two to three week period. At the time of my study, last Friday, the S&P 500 had rallied 27% in two weeks from the March 23 lows and 21% from the close on March 20^th. In total there have been 39 other such instances in history of the S&P 500 going back to 1928, with 27 of those instances taking place in the 1930’s. Each of these instances, also not surprisingly, occurred after the market had fallen fairly precipitously from its prior highs, the average being a 59.5% drawdown from the market’s highwater mark to the point before the rally began. Essentially, these types of rallies have only occurred during stressed market environments.

The purpose of my study was to examine what the market did next, in the aftermath of the rally from the depths of despair. First, I started by looking at the 52-week forward return following the 15%+ two to three week rally. Of the 39 periods 1/3 of those had one year negative returns, and the average 52 week return for all 39 instances was 14.7%. Seeing these results my intuitive brain took an ego shot. Maybe I’m wrong. Maybe the market’s bounce is causing cognitive dissonance because I’m apply current conditions while the market is applying forward conditions. Being prideful and unwilling to admit defeat I dug a bit deeper…

Of the 27 periods with positive 52-week forward returns the average preceding drawdown had been 62%. When this current market rally began the S&P 500 was only down about 26% from its all-time highs. So maybe the reason the market responded well in those instances is the market had been incredibly beaten-down and valuations were much more attractive. Data provides a lot of information, but it rarely provides reasons—that’s what intuition does. Data only shows that the returns following more significant drawdowns were superior to returns following less significant drawdowns. Of the 12 periods with negative forward 52 week returns, the average preceding drawdown was only -23.5%, much closer in line with the 26% drawdown we’d recently experienced. This information appeased my intuitive nature. After all, isn’t where we go a function of where we’ve been or where we are?

But remembering that I’m already dealing with a fairly small sample size I decided to do one more study which incorporated all of the 39 periods. Also remembering that there are very few free lunches in the world, I wanted to see the amount of pain in the positive periods had to be experienced to get to those one year out positive gains. To get the chance to make those returns it should come at some sort of cost. During the positive periods the average pain experienced before achieving the 52-week gains was 12.65%. That means that the market fell, on average 12.65% before it rallied to finish the 52-week period.

My study is far from scientific, but it might provide some context for the current market climate. Maybe this recovery is for real, maybe it’s not. Either way it seems like the current market levels, viewed through an historical context, should make us a bit cautious rather than bold.

   Disclosures

All opinions are subject to change without notice. Neither the information provided, nor any opinion expressed, constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results.  Tax laws are complex and subject to change. Calibrate Wealth LLC, does not provide tax or legal advice and are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise provided in writing by Calibrate Wealth. Individuals are encouraged to consult their tax and legal advisors (a) before establishing a retirement plan or account, and (b) regarding any potential tax, ERISA and related consequences of any investments made under such plan or account.

This material does not provide individually tailored investment advice. It has been prepared without

regard to the individual financial circumstances and objectives of persons who receive it. The strategies

and/or investments discussed in this material may not be suitable for all investors. Calibrate Wealth

recommends that investors independently evaluate particular investments and

strategies, and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a

particular investment or strategy will depend on an investor’s individual circumstances and objectives.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of

factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii)

governmental programs and policies, (iii) national and international political and economic events, war

and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities

and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other

disruptions due to various factors, including lack of liquidity, participation of speculators and

government intervention.

Foreign currencies may have significant price movements, even within the same day, and any currency

held in an account may lose value against other currencies. Foreign currency exchanges depend on the

relative values of two different currencies and are therefore subject to the risk of fluctuations caused by

a variety of economic and political factors in each of the two relevant countries, as well as global

pressures. These risks include national debt levels, trade deficits and balance of payments, domestic and

foreign interest rates and inflation, global, regional or national political and economic events, monetary

policies of governments and possible government intervention in the currency markets, or other

markets.