Record Speed to Record Highs

On Wednesday, the MSCI World Index hit a new record high when measured in pounds and including reinvested dividends—officially rendering the rise since 16 March a new bull market (prolonged period of generally rising equity markets).^[i] It is a notable milestone with much for market historians to mull over, but we think it likely means little for shares going forward. 

It took markets about five and a half months to climb from the low to a new high—a swift climb that, in our view, is a fitting follow-up to the preceding bear market (fundamentally driven equity market decline of -20% or worse). That downturn, which began for global shares on 20 February (when the MSCI World Index peaked in Sterling), was history’s fastest (meaning, the quickest to fall from the peak to -20%) and shortest.^[ii]

In our view, this year’s bear market behaved much more like a correction (sharp, sentiment-driven decline of around -10% to -20%) than a typical bear market. It was a full-fledged bear market in magnitude and had a fundamental cause (the forced closure of in-person commerce globally to contain COVID-19), but it was short and sharp. It didn’t begin gradually, and—crucially—it didn’t last long enough for value shares (companies that tend to invest less in growth-orientated endeavours and generally trade at lower prices relative to corporate earnings) to endure their typical panicky bear market pounding. Our research shows value shares typically suffer in a long bear market as they are unable to secure new financing, fuelling fears of bankruptcies. That didn’t happen this time, which our analysis suggests made it unlikely they would bounce much higher than other categories the new bull market—and they haven’t.^[iii] Sector leadership hasn’t changed from the prior bull market’s home stretch, either. Our research shows the sectors and styles leading into a correction typically continue doing so when the correction ends—and, a few brief blips aside, large, growth-orientated companies haven’t relinquished their leadership. (Growth shares, unlike value, generally invest in projects aimed at growing earnings and revenues over time and trade at relatively higher prices compared to their earnings.) Tech and Tech-like companies led as the last bull market matured, led during the bear market, and have outperformed handsomely during the recovery.^[iv] We think these trends are unlikely to change in the foreseeable future.

Although we think the recovery’s speed and other characteristics are noteworthy from a style and portfolio construction standpoint, we don’t think they predict returns from here—for better or worse. Though we believe the most likely scenario is that global markets end the year with positive returns, this doesn’t mean returns will continue at a similar pace as the past five months for the rest of 2020. Our study of market history shows bull markets usually slow down after the initial burst, and it isn’t unusual to get a correction early on. But a sharp return to new lows seems unlikely to us and, indeed, would be unprecedented.^[v] Moreover, that kind of downturn wouldn’t happen for just any reason. In our view, it would require some new, huge negative that markets haven’t yet reckoned with. Although this is possible, successful long-term investing is based on probabilities, not possibilities, in our view.  

Absent a new huge negative, our assessment of investor sentiment suggests this bull market has a long way to run, as we seem quite far removed from the euphoria that often accompanies equity market peaks. Our analysis shows investors remain broadly pessimistic. Headlines warn equities have come too far, too fast and are disconnected from reality in a supposedly false recovery. Financial commentators we follow continue warning about a second shoe to drop—e.g., a new COVID outbreak leading to another global economic shutdown. Not to mention other big alleged risks, including inflation, bankruptcies, high unemployment—all of which are normal to see in headlines as equities recover.

When these worries linger as markets approach breakeven, it usually triggers a condition we call breakevenitis—investors’ urge to sell when equities approach pre-bear market levels out of fear of a renewed drop and losses. Selling at the prior peak seems like a sensible way to avoid locking in past bear market declines and avoid a second round of pain: a win-win! However, we think this is a mistake, and history shows it can be a costly one. Exhibit 1 shows this using America’s S&P 500 Index in US dollars for its long history.

Exhibit 1: S&P 500 Returns From First All-Time High to Next Peak, 1950 – 2020

Source: Global Financial Data and FactSet, as of 12/8/2020. S&P 500 Index Price Level, 29/5/1946 – 11/8/2020. Presented in US dollars. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.

In our view, there is nothing magical about breakeven. The first all-time high in a bull market is usually one of many before the eventual peak. The fears splashed across headlines daily aren’t reasons to sell, in our view—they are all too widely discussed. If financial commentators are any indication, investors have been mulling over them for weeks or months. We strongly suspect these issues will go down in history as the foundational bricks in this bull market’s proverbial wall of worry, benefitting long-term growth-orientated investors who remain patient and disciplined.