The All-Time High Bad News Couldn't Block

The S&P 500 price index hit a new all-time closing high Friday, capping nearly two and a half months of volatility. While record highs are a dime a dozen in bull markets, we think this one demonstrates a crucial point: Stocks are forward-looking and always price in widely expected events—even if that includes bad news.

Think back to September 2, the S&P 500’s prior all-time high. Pundits preached that the summer’s big rally was a fluke. They said stocks had come too far, too fast, and would sink when COVID’s inevitable autumn resurgence triggered new restrictions. A messy election with delayed results would deliver another sucker punch, and stocks would erase most of their recovery since late March. That, at least, was the popular theory.

For much of September and October, volatility might have had you thinking this thesis was correct. The S&P 500 endured twin pullbacks, twice coming very near to correction territory (down -10% from the prior high). COVID indeed flared up again, stalling reopening in much of the country. Some cities (most notably Newark, Chicago and Denver) added new restrictions. Across the pond, much of Western Europe re-entered lockdowns, to varying extents. By Halloween, with the election looming, the mood in markets and headlines alike was very grim.

But then the rally began, erasing the two-month pullback in just two weeks. 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 the widely feared recounts and legal challenges became reality. Both of Georgia’s Senate seats headed toward January runoffs, leaving party control unknown. Everything the world feared came to pass, but stocks rose through it all.

Let this be a lesson: Bad news isn’t always bad for stocks. 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. All summer, pundits 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. Markets spent months dealing with talk of new restrictions. By the time they materialized, people had been trading for weeks with the knowledge that they were looming. That is what we mean when we say markets are efficient: Prices reflect the common knowledge, opinions, hopes and fears of every market participant. Those likely to act on those thoughts probably do so then. So when restrictions returned, 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. 

Some will inevitably say, of course stocks rallied back to all-time highs—we had some great vaccine news! True enough. But sentiment toward this news wasn’t exactly torrid. Even as pundits acknowledge the benefits, they warned vaccine progress wouldn’t automatically prevent a winter lockdown and its economic destruction. A vaccine might help people, they said, 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 skeptical a vaccine will be safe and/or effective. They wrote the rally that accompanied the news off as irrational exuberance.

Sure, sentiment probably played a role there. But even if there hadn’t been a big burst, it wouldn’t alter our general thesis that stocks aren’t focused on the here and now: 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 while going about our normal business. Having a vaccine candidate be so successful in Phase 3 trials helps stocks get a clearer view of that endgame. But life going back to normal doesn’t depend on this or any vaccine saving the day. Society is very good at adapting and overcoming challenges, including disease.

Most importantly, today’s new high shows the importance of not reacting to volatility. Anyone who sold out in late October, fearing a locked-down Europe and messy election would sink stocks, got whipsawed fast. Enduring short-term pullbacks isn’t fun, but they ultimately don’t hurt your long-term returns as long as you capture the ensuing rebound. As these last two weeks show, that can happen fast—and when you least expect it.