Two weeks ago, we wrote about the different bear markets in the Philippines (see Different Bears, April 6). Now, let us look at two US bear markets for guidance.
Similarities with 1929
The 2020 bear market has similarities to events that happened during the Great Depression. Back then, the US economy shrank 50 percent from 1929 to 1933. Unemployment shot to a high of 25 percent in 1933. Today, entire countries have shut down, large portions of the global population quarantined, businesses are grinding to a halt, and financial markets are in turmoil. Calling this “Great Lockdown” the worst economic downturn since the Great Depression, IMF projects global GDP to shrink by three percent, dwarfing the 0.1 percent downturn in 2008.
The 1929 bear market
The 1929 stock market crash was a prolonged decline. From peak to trough, the bear market took almost three years to unfold. Initially, a swift three-leg decline from September to November 1929 brought the Dow down by 49.4 percent. The Dow then rallied 52 percent into April 1930, but was rejected at the 200-day moving average. (refer to left chart).
After rallying for six months, the Dow resumed its downtrend. There was a series of 20 to 30 percent rallies during this bear cycle, but each one failed and formed new lows. The Dow finally bottomed out in July 1932, falling as much as 89 percent from its 1929 peak. (refer to the right chart)
Similarities with 1987
Many Wall Street veterans say that the 1987 crash was primarily a trading event, not a fundamental or economic one. In the days leading to the Oct. 19, 1987 (Black Monday) crash, the US House ways and means committee introduced a takeovers tax bill that placed restrictions on corporate takeover. This news triggered an avalanche of selling of takeover stocks. Portfolio trading strategies such as risk arbitrage and portfolio insurance reinforced the selling wave, which worsened the decline.
The current market crash is similar to 1987 in that deleveraging and forced margin liquidations exacerbated the volatility and the ensuing price decline. Today, the selling of giant hedge funds and quant or systematic funds employing volatility-targeting and risk-parity strategies is said to have worsened the market rout. Bloomberg reported that several hedge fund hotshots such as Ray Dalio, Michael Hintze and Adam Levinson suffered their worst ever losses last month due to the coronavirus-led turmoil.
The 1987 bear market
The 1987 crash was fast and sharp, with the S&P 500 dropping 36 percent over two months. Similar to 1929, this bear market had two legs, although one might argue that a third leg might have formed, which retested the low registered on Oct. 20, 1987 (refer to the left graph). By June of 1988, the Dow broke above its 40-week MA and resumed its longer-term upward move. (refer to the right chart)
What do we do with this reaction rally?
While the IMF expects a three percent contraction in global GDP this year, it projects a 5.8 percent growth in output in 2021. Historically, the market tends to bottom six to 12 months ahead of the economy. Hence, the lows may be in – if one believes that the economy will be well ahead of where we are today, at least in terms of growth.
As of Friday, the S&P 500 index has retraced more than 50 percent of its losses. Will this reaction rally going to be like 1929, where it would quickly fall apart and make new lows in the years to come? Or will this be like 1987, which will turn out to be the cusp of a multi-year bull market?
All of these things will be resolved if the lockdowns, quarantines, social distancing and testing measures prove effective in containing and reducing the number of infections and deaths. More importantly, finding an efficacious treatment and a vaccine for the coronavirus disease 2019 or COVID-19 will pave the path for the recovery of the economy and the financial markets.
Philequity Management is the fund manager of the leading mutual funds in the Philippines. Visit www.philequity.net to learn more about Philequity’s managed funds or to view previous articles. For inquiries or to send feedback, please call (02) 8250-8700 or email ask@philequity.net.