New Bull Emerges in a Market Riskier Than It Appears

The S&P 500 is once again at all-time highs.

Month ending July 2020 total return data indicated the S&P 500 index had recovered all of its March drawdown, officially marking the end of the CV-19 bear and declaring a new bull market, which began last April. Unlike bears, which are announced as soon as the market swoons 20% from previous peak, bulls are known only in retrospect … although granted definitions vary. Commonly, a bull needs to climb 20% off its last maximum drawndown and subsequently go on to achieve its next all-time high; basically, it needs to get back above water before becoming official. That happened in July.

The following table summarizes the US bear and bull markets dating back to the Great Depression, which updates the version found in “A Presumptive Bear Ends an 11-year Bull Run.” Like before, the results presented below use the monthly database maintained by Amit Goyal, but updated as appropriate from January 1960 through July 2020 with our Lipper Global Data Feed.

The identifiers Cycles 1-6 are maintained for consistency with previous studies and with evaluation period nomenclature used in MFO’s screening tools. Added are three earlier cycles (E1-3), which takes the table back to the beginning of the worst market drawdown in US history … The Great Depression. You’ll note new common names, which will generally contain the event, person, or entity most identified with the cycle period. As before, a full cycle comprises both a bear market and subsequent bull market.

You’ll note that even when including the Great Depression, the amount of time the S&P 500 spends in bear territory is a small fraction of the time it spends in bull territory, which is nearly 90%!

This rather dramatic statistic is often depicted graphically by sell-side market analysts and brokerages of equities. Here’s a link to an example published by Invesco, entitled “Bear and bull markets – historical trends and portfolio impact.” You’ll see a lot of green!

What the graphic or table above does not call attention to is the amount of time required to recover the drawdown caused by the previous bear market. The so-called recovery time or time your investment is “under water.”

Before revealing that detail, a couple more points about the table above:

Firstly, the average annualized return of the eight bull markets prior to the current on-going one is 18%. Per year! That’s hard to resist.

In late 1990’s I assumed responsibilities for my family’s trust and I remember asking my dad how much return he expected from his stock broker each year. The broker maintained a portfolio of around 30 mostly blue-chip stocks. My dad quickly responded: “If he doesn’t deliver 20%, fire him.”

Can you believe that?

And yet, in the 1990’s here are the annual S&P 500 returns: 1999 (21%), 1998 (28%), 1997 (33%), 1996 (23%), 1995 (37%). He was used to receiving 20% each year, at least!

Secondly, investors should brace for retractions of 30-40% during any bear market. But it’s been as bad as -83% and as mild as -20%. (Actually, month ending retraction for the CV-19 bear at its trough only reached -19.6%, but intra-month it certainly crossed below -20%, so we’ve conceded the bear. Similarly, it remained below -20% for just one month, but we’re declaring it a bear nonetheless. Same with the Cuban Missile Crisis bear of 1962.)

Thirdly, I used to believe that a retraction like that of the Great Depression were not realistic for the broad market given the creation of the SEC, market circuit breakers to curb panic selling, the proactive nature of the Fed with monetary policy, and willingness of Congress to act on fiscal policy. But after March, especially, I find that view naive and convenient.

While catastrophe was averted, yet again, there were moments when many were crying “Mayday” and punching the sell button, which led to illiquidity in investment grade assets and illiquidity hell in junk markets. Ditto during GFC, when financial markets teetered on the brink, as described in Timothy Geithner’s “Stress Test.” (Also see Michael Lewis’ review “The Hot Seat.”)

All of our processes and initiatives did not prevent an 80% drawdown in QQQ during the Dotcom bubble, as described in “How Bad Can It Get?” Or prevent companies like Telsa from trading at 250 times future earnings … and Tesla could become a major component of the S&P 500. Thomas Levenson’s recent article is a reminder to us all: “Investors Have Been Making the Same Mistake for 300 Years.”

Going forward, all articles on market cycles in Charles’ Balcony and evaluation tools on MFO Premium site will include performance of the Great Depression and evaluation periods back to 1926.

OK, below is a table depicting the same nine cycles shown above, but now revealing a riskier market than typically conveyed. It indicates months under water during each cycle, including months below -20% drawdown, which most investors consider real pain … the level when “Ulcer Index” gets your attention. The table reveals that buy-and-hold investors can expect to be under water relative to the preceding bull market peak 42% of the time. Furthermore, since new all-time highs occur 30% of the time, investors should brace for some level of drawdown 70% of the time.

The average annualized return across the full cycles is a compelling 9%, while excess return, that amount above risk-free 90-day T-Bill return, is just 5%. I suspect the latter number is not one that comes to mind when equity investors allocate large portions of their portfolios to SPY or VFINX. That number is more associated with the long-term return of risk-free investing, like you’d once get in a regular passbook savings account.

The table also indicates an average recovery time of 4-5 years, but as long as 7 in recent times during the Dotcom Bubble and 15 during the Great Depression. These long period help explain why companies like Morningstar mention “investment horizons longer than 10 years” for equity heavy portfolios.

During this year’s Berkshire Hathaway annual meeting, Warren Buffett stated the following:

And with that, I hope I’ve convinced you to bet on America. Not saying that this is the right time to buy stocks if you mean by “right,” that they’re going to go up instead of down. I don’t know where they’re going to go in the next day, or week, or month, or year. But I hope I know enough to know, well, I think I can buy a cross section and do fine over 20 or 30 years. And you may think that’s kind of, for a guy, 89, that that’s kind of an optimistic viewpoint. But I hope that really everybody would buy stocks with the idea that they’re buying partnerships in businesses and they wouldn’t look at them as chips to move around, up or down.

What struck me was the “… or 30 years” part.

Fact is buy-and-hold investors who have been investing for the past 20 years are currently suffering the lowest returns since those that had invested through the Great Depression. Basically, just about 6% annualized. And they only had to live through three bear markets to earn that! Robert Shiller’s prescient “Irrational Exuberance,” predicted as much in 2000.

For the past 30 years? Investors have earned closer to 10% annualized. In fact, they have never earned less than 8% nominally since 1926.

I suspect Mr. Buffett knew exactly what he was talking about.