The All-Time High Bad News Couldn't Block

The MSCI World Index hit a new all-time closing high on 9 November, capping nearly two and a half months of volatility.^[i] Whilst record highs are common in bull markets (extended periods of rising equities), we think this one demonstrates a crucial point: Shares are forward-looking and typically price in widely expected events, in our view—even if that includes bad news.

Think back to 2 September, when the MSCI World registered its first all-time high in this new bull market.^[ii] Market observers in financial publications we follow preached that the summer’s big rally was a fluke. They argued equity markets had come too far, too fast, and would sink when COVID’s inevitable autumn resurgence triggered new restrictions. A messy US presidential election with likely delayed results and a looming “no-deal” Brexit would stoke political uncertainty. All these negative developments would allegedly erase most of global equities’ recovery since mid-March. That, at least, was the popular theory we observed.

For much of September and October, volatility might have had you thinking this thesis was correct. Global equities vacillated regularly. After 2 September’s high, the MSCI World Index ended the month down -2.2%.^[iii] Then global equities rose in October’s first two weeks—recording a new all-time high on 13 October.^[iv] Global shares then retreated -6.5% in the month’s final two weeks as COVID cases—and new restrictions—picked up in the developed world.^[v] By Halloween, France and Germany had enacted new nationwide measures and UK Prime Minister Boris Johnson announced a new lockdown—putting markets and headlines alike in a grim mood.

But then the rally began, bringing the MSCI World back to new all-time highs in less than two weeks.^[vi] Yet the news didn’t turn positive. Europe was still locked down (but not as badly as in the spring). Cases kept rising in America, with more states and localities reacting with various renewed restrictions. The US election didn’t resolve immediately, leaving investors in the dark for days, and recounts and legal challenges became reality. The UK and EU still didn’t reach a new trade agreement. All the seemingly negative events financial commentators warned of came to pass, but equities rose through it all.

Let this be a lesson: Bad news isn’t always bad for shares. In our view, what matters is whether the bad news is a surprise. Early 2020’s lockdowns were a shock—a massive one. But they also put the world on high alert for a repeat. As we tracked the news in financial headlines, all summer, commentators warned reopening and economic relief were temporary, and cold weather’s return would end the party as people retreated indoors, allowing COVID to spread again. We think markets spent months dealing with talk of new restrictions. By the time they materialised, people had been trading for weeks with the knowledge that they were looming, based on our understanding and experience. That is what we mean when we describe markets as efficient: Share prices reflect the common knowledge, opinions, hopes and fears of market participants. Those likely to act on those thoughts probably do so then. So when restrictions returned, we think they were already incorporated into prices. That didn’t stop them from hitting sentiment temporarily, as bad news often does, but their fundamental influence was sapped, in our view. 

Some may argue, of course equities rallied back to all-time highs—we had some great vaccine news! We think that argument has some merit. But sentiment toward this news didn’t seem exactly torrid to us. Even as many commentators we follow acknowledged the benefits, they also warned vaccine progress wouldn’t automatically prevent a winter lockdown and its economic destruction. A jab might help people, the argument went, but it wouldn’t inoculate the economy against all the long-term problems the pandemic was already causing. Still others cite polls showing much of the public is sceptical a vaccine will be safe and/or effective.^[vii] These doubts suggest a cohort sees irrational exuberance in the latest rally—and thinks markets are disconnected from reality.

We agree sentiment probably played a role in equities’ early-November rise. But even if there hadn’t been a big burst, it wouldn’t alter our general thesis that equities aren’t focused on the here and now: We think they are looking more toward the next year, two or three, to a time when the virus is old news and we have all learned how to live with it whilst going about our normal business. Having two vaccine candidates be so successful in advanced trials likely helps shares get a clearer view of that endgame. But life going back to normal doesn’t depend on this or any vaccine saving the day, in our view. Based on our research, society is very good at adapting and overcoming challenges, including disease.

Most importantly, we think November’s new high shows the importance of not reacting to volatility. Investors who sold out of equities in late October, fearing a locked-down Europe and messy US presidential election would sink their portfolio, may have missed shares’ quick recovery. Enduring short-term pullbacks isn’t fun, but market history shows they ultimately don’t hurt investors’ long-term returns as long as they capture the ensuing rebound.^[viii] As these last two weeks show, that can happen fast—and when you might least expect it.