Looking Through The Smoke

Posted on April 10, 2020 by Gemmer Asset

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There have been 10 bear markets in the S&P 500 since 1950 (defined here as a -20% drawdown in the index price from a market high). The below chart shows the historical drawdowns in the index:



Pretty scary huh? Let’s add to the chart and show the subsequent bull markets:



Really puts those drawdowns in perspective doesn’t it? If you include dividends in the December 1987-March 2000 period, the gain is +841.4%! Yes, bear markets are tough to stomach – there’s no getting around that, but when you link them with the subsequent bull markets, you realize that in most cases they are fairly quick and the market ultimately bounces to new highs. To quantify that realization, let’s take a look at the “average bear” vs the “average bull” since 1950:



On average, bull markets are about 4.5 times longer in duration than bear markets and the absolute value of returns is much greater in an average bull market. Remember, new bear markets happen because new highs were made.


When bear markets happen, take comfort in the fact that they will ultimately end, and the subsequent bull market will be worth the wait. But how and when do bear markets end?


Markets Are Forward Looking Even When We Aren’t


One thing that’s so difficult to stomach in a bear market is the news flow – it makes us mutter to ourselves “when is this going to end?!”. Bad headlines seem to be everywhere and combined with market losses; it feels pretty depressing. One thing to focus on is that markets are forward looking. Bear markets tend to bottom while headlines and negative events are still raging. Take the financial crisis for example. The market bottomed in March of 2009 – a peak to trough drawdown of -56.8% – and here are just a few of the major negative events that happened after that:


• Unemployment rate peaked in October of 2009 at 10%:



• Bankruptcies in the U.S. peaked in June of 2010:



• U.S. didn’t emerge from recession until July 2009:



• Mortgage defaults peaked in June of 2009:



The list goes on. The point here is that the market bottomed BEFORE all this bad news. But in March of 2009, things weren’t all sunshine and rainbows – it still felt pretty bleak.


Another example is in the bear market that started in 1973, which lasted until October of 1974 when the S&P 500 hit a bottom. Jobless claims peaked in January of ’75 and the economy was in recession until April of ’75. There are many examples of this dynamic, but you get the point – again, markets looked through the smoke.


Why is this the case? Kamakshya Trivedi and Zach Pandl from Goldman Sachs wrote in a recent research report that markets tend to bottom in crises only when they can rule out deep tail risks:


”The core insight is that while conditions are deteriorating rapidly, markets find it hard to be confident in the limits of the damage and so put heavy weight on deep negative tail risks. Inflection points are often, in the first instance, about the market being able to put limits on those tail risks even before true recovery is visible.”


This is precisely what happens in bear market bottoms. If the market can put a line in the sand to gauge how bad the damage will be, even if that damage is crushing, investors can start to think about what a recovery might look like.


While markets in general are forward looking, individual investors tend to react to what’s happening in the here and now. If in 2009 for example, you waited for the unemployment rate to peak in October before getting back into equities, you would have missed out on a +55.3% gain in the S&P 500.



Making wholesale changes based on current events (that may have already been priced in) is a big part of the reason why individual investors lag most major asset classes when it comes to actual returns. The below chart shows how the average investor has done relative to most major asset classes over the last 20 years… just shy of inflation.



So, the million-dollar question: was March 23, 2020 this bear market’s bottom? We can’t say. Trivedi and Pandl cited 6 conditions needed for the market to put defined limits on the big tail risks and possibly bottom out:


1) A stabilization or flattening out of the infection rate curve in the US and Europe

2)  Visibility on the depth and duration of disruptions on the economy

3) Sufficiently large global stimulus

4) A mitigation of funding and liquidity stresses

5) Deep undervaluation across major assets and position reduction

6) No intensification of other tail risks


Points 3 and 4 have arguably been satisfied. But there is still a fair bit of uncertainty in the others. The longer this crisis goes on, the greater the possibility for other unknown tail risks to emerge. So, if you’re going off of these points and the fact that within most bear markets there are mini bull rallies followed by a retesting of the lows, we may not be in the clear. However, because this crisis is unlike any other in the modern era, anything is possible.


How about something we do know? If bad news is expected and can be roughly measured/defined, markets can price in that news and move on.


Hopefully when it looks through the smoke, it sees something good.





Published by Gemmer Asset Management LLC The material presented (including all charts, graphs and statistics) is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. The material is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objective, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this material is suitable for their particular circumstances and, if appropriate, see professional advice, including tax advice. The price and value of investments referred to in this material and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Fluctuations in exchange rates could have adverse effects on the value or prices of, or income derive from, certain investments. No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of Gemmer Asset Management LLC (GAM). Any mutual fund performance presented in this material are used to illustrate opportunities within a diversified portfolio and do not represent the only mutual funds used in actual client portfolios. Any allocation models or statistics in this material are subject to change. GAM may change the funds utilized and/or the percentage weightings due to various circumstances. Please contact GAM, your advisor or financial representative for current inflation on allocation, account minimums and fees. Any major market indexes that are presented are unmanaged indexes or index-based mutual funds commonly used to measure the performance of the US and global stock/bond markets. These indexes have not necessarily been selected to represent an appropriate benchmark for the investment or model portfolio performance, but rather is disclosed to allow for comparison to that of well known, widely recognized indexes. The volatility of all indexes may be materially different from that of client portfolios. This material is presented for informational purposes. We maintain a list of all recommendations made in our allocation models for at least the previous 12 months. If you would like a complete listing of previous and current recommendations, please contact our office.


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