A look at history reveals the right time to buy (and not to buy)
- With global markets consolidating to the downside, is now the time to start pouncing on deals?
- When equity markets crash by 30% or more, when is the buying opportunity? Let’s look at history. I also look at the stock market performance during three prior pandemics (1918, 1957–1958, ad 1968) for guidance.
- Based on historical lessons (and a comparison to this situation and a prospective recession in Q2), there is more downside in equities near term (don’t rush!) but I expect a bottom to begin forming in the next one to two months.
“The stock market is like a no-called-strike game. You don’t have to swing at everything — you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, ‘Swing, you bum!’”
— Ben Graham
What a month, quarter, year we’re having. It’s ugly out there, but we may be reaching a bottom soon.
One thing that I look at is the VIX, which is the volatility index created by the Chicago Board Options Exchange (CBOE) the Volatility Index. This is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors’ sentiments. The VIX recently peaked at 82.69, a level not seen since December, 2008, and has more recently subsided to about 59.65 (as of March 24).
In the past, when the VIX hits these types of levels and then starts to decline, that type of action has been associated with market bottoms. It didn’t always indicate a reversal of the trend in the S&P 500, but it usually suggests that a low is beginning to form.
Exhibit 1: Recent and Historical VIX
Source: Bespoke Investment Group
So when exactly is the right buying opportunity?
I looked at six different instances since the Great Depression when the S&P 500 fell by 30% or more from its peak. This is the seventh time that this type of bear market has happened (as of March 24th, the S&P 500 is roughly down 31% from its peak on Feb. 12).
Looking at the prior six events, if you had bought the S&P 500 just as the 30% threshold was breached, you would have made money 90 days out in three of those instances, and lost money the other three times. Note that the risk is asymmetrical to the downside, meaning that losses (particularly the 1973–74 decline and the 2008–2009 “Great Recession”) overwhelmed the winners.
But looking out 6 months, the risk is positively skewed; you would have been ahead 4 out of the 6 times, with the winning trades collectively much more successful than the losing trades. And looking ahead 2 years from the trough, you would have made money … and a lot of it … every time except during the Great Depression and in the aftermath of the historic dot-com bubble.
In several of those instances, the real economy experienced recessions (mild ones in 1969–1970, and 2001; a steeper one in 1973–1975 that may be more like what economists are projecting in Q2-Q3 2020).
Exhibit 2: S&P 500 Moves, After a 30% Decline from a Peak
My overall conclusion here is this is a rare buying opportunity on the S&P 500, if you believe the following things:
- This isn’t a repeat of the Great Depression. That event was caused in part by the Federal Reserve not preventing the sharp drop in the money supply that took place during the period 1929–1933, in part by the Smoot-Hawley tariff in 1932, and in part by a series of escalating tax increases (Herbert Hoover raised tax rates from 25 percent to a maximum of 63 percent, and Franklin Roosevelt boosted them to 79 percent later in the decade). We will have a much more constructive set of responses from the government this time around.
- This is also different from the events of 2000 (probably). The run-up from 1995 to 2000 saw a quintupling of the stock market, and the market advance was very uneven … in 1999 for instance, the S&P 500 rose 20% (and the NASDAQ 100 rose by 86%) but more stocks fell than rose. The Fed was in an aggressive tightening mode in early 2000. Also, the events of 9/11 hit just as we were in the midst of the recession. This time around, the real economy is starting off on sounder footing. At the outset of 2000, the PE ratio on the S&P 500 was between 29 and 32 times trailing earnings, about 50% higher than it was at the market’s peak in February 2020. (As of March 24th, 2020, the S&P’s PE ratio on trailing earning is about 18x).
- Socially, we are not going to undergo a severe curtailment of individual freedoms, and a continuation of these conditions approximating martial law, forever. There will likely be more social distancing, more pain, more isolation over the next few months. The world has had worse things to deal with and come out stronger — this time will be no different.
The Spanish Flu pandemic of 1918 offers an analogy to guide how we might think about the U.S. stock market amid today’s crisis. The Spanish Flu was an unusually deadly influenza pandemic that lasted from January 1918 to December 1920. It infected 500 million people — about a quarter of the world’s population at the time. When it was all over, that pandemic killed an estimated 675,000 Americans among a staggering 20 to 50 million people worldwide.
We do not know if the Coronavirus pandemic will reach prevalence similar to that of the Spanish Flu, nor do we know the fatality rate with high confidence. But the swift death of between 1% and 6% of the population is a disturbing proposition, and it is not an unthinkable outcome for Coronavirus given where we are today.
Back in 1918, this outbreak came right on the heels of a 25% of decline in the S&P 500, which tracked back to the spring of 1917 (when Woodrow Wilson announced that the US was joining World War I). Investors would have actually recaptured those losses by July 1919. Then the market fell again, subjecting investors to a 30% hit.
But what followed was a long, decade-long upwards march — punctuated by short recessions (and buying opportunities ) in 1923 and in 1926.
The Spanish Flu actually hit in three waves — the first made people notice the flu, and occurred in July 1918. The second and most deadly wave occurred in October 1918 and resulted in millions of deaths worldwide. The final wave of the pandemic occurred in February 1919, and after that, it disappeared. If you look at the S&P 500 in 1918 and 1919, you can see that the stock market was relatively unaffected by any of the three waves of the Spanish Flu.
Of course, the Spanish Flu occurred in 1918 while World War I was raging in Europe so the war had a larger impact on the stock market than the flu. There were few if any global supply chains that the Spanish Flu could disrupt because the war made supply chains nonexistent. The second and worst wave of flu occurred at the end of World War I when peace was finally achieved after four years of devastating destruction.
Here is the stock market performance starting six months before the flu epidemic, and six months after.
Exhibit 3: S&P 500 During the Spanish Flu Outbreak, 1917–1921
It’s worth looking at a few other examples of global pandemics, and how the market performed. One was the “Asian Flu,” first reported in Singapore in February 1957. It reached Hong Kong by April, and reached the U.S. by June of 1957. The fatality rate was about 0.7%. The global death toll was about 1.1 million people. In the United States about 116,000 people died, with most deaths occurring between September 1957 and March 1958. (The US population then was about half what it is today.)
Stocks started selling off as soon as the virus reached U.S. shores in June 1957. They lost about 12% within 4 months, and didn’t start to recover until U.S. deaths began to decline in March 1958.
Then there was also a “Hong Kong Flu” in 1968, first reported in Hong Kong in July 1968. It reached India, Australia and Europe by September, and was widespread in the U.S. by December 1968. The fatality rate was below 0.5%. The global death toll was about 1 million people. About 100,000 people died in the U.S. (or 0.5% of the population), with flu deaths peaking by March 1969.
Exhibit 4: S&P 500 - Performance During Other Pandemics
Now, let’s look at each of six prior instances of a 30% correction a little more closely, and analogize more tightly to the current situation:
1929: Great Depression
In 1929, the initial crash presaged a decade-long decline in economic activity. Buying once the index was 30% below its peak would have been far too early, as the markets experienced a short recovery before plunging another 40% over the next 12 months, and eventually another 90% over the next decade.
Exhibit 5: “Great Depression”
1968: Vietnam War decline
From December 1968 to about the fall of 1970, the stock market stumbled. A a relatively mild recession began in December of 1969, ending in November 1970. It was a fairly gentle recession — GDP shrank just 0.6% during thi period. In December 1970, the rate reached its height for the cycle of 6.1 percent. This relatively mild recession coincided with an attempt to start closing the budget deficits of the Vietnam War (fiscal tightening) and the Federal Reserve raising interest rates (monetary tightening).
In this fairly mild recession, the market bounced back quickly, and buying during the recession would have been a winning move.
Exhibit 6: Vietnam Era Recession
1973: the Stagflation Era
The first 1970s recession was a period of economic stagnation in much of the industrialized world during the 1970s, and it put an end to the overall expansion that characterized post-WWII. The market took almost two years to lose 30% of its value, from the market peak in January 1973 — it didn’t find bottom until September 1974, when the market overall lost 47% of its value.
In that particular instance, buying once the market lost 30% (in mid-1974) was definitely too early. But then, a lot things happened between Jan. 1973 and September 1974: a quadrupling of oil prices; the start of a US recession (it began in November 1973); the loss of over 2 million jobs; inflation soared from 3.6% in Jan. 1973 to 12.0%; and the resignation of Richard Nixon. In May 1975, the rate reached its height for the cycle of 9 percent.
Exhibit 7: “Stagflation”
Is this time around going to be as bad?
I doubt it … the underlying economy is extremely strong; oil is cheaper now than then; inflation is subdued; corporate profits are in much better shape now than I n1974; and the time that it takes to normalize the economy after the COVID-19 peak appears to be 6–9 months, not the 3 years it took to recover in th 1970s.
1987: the “Flash Crash”
The stock market crash of 1987 was a rapid and severe downturn in U.S. stock prices that occurred over several days in late October of 1987. While the crash originated in the U.S., the event impacted every other major stock market in the world. On October 22, 1987 — known as “Black Monday” — the DJIA fell by 508 points, or by 22.6%, the largest percentage drop in one day in history.
The Fed subsequently intervened by installing mechanisms called “circuit breakers,” designed to slow down future plunges and stop trading when stocks fall too far, too fast. There were a few issues that created this crash: heightened hostilities in the Persian Gulf, fear of higher interest rates, program trading, a five-year bull market without a significant correction, and perhaps most importantly the Fed began tightening monetary policy under the new Louvre Accord to halt the downward pressure on the dollar in the second and third quarters of 1987. As a result of this contractionary monetary policy, growth in the U.S. money supply plummeted by more than half from January to September, interest rates rose, and stock prices began to fall by the end of the third quarter of 1987.
Exhibit 8: the “Flash Crash”
Here, as Exhibit 6 shows, the market recovered almost immediately, There was no recession in the real economy. Buying the dip proved smart, as the market fully recovered and in fact traded hgher with a year.
2000: the “Dot Com Bubble”
Between 1995 and 2000, the stock market experienced an unprecedented run-up in valuations, with the NASDAQ rising 400% only to fall 78% from its peak by October 2002, giving up all its gains during the bubble.
Even though the Nasdaq Composite rose 85.6% and the S&P 500 Index rose 19.5% in 1999, more stocks fell in value than rose in value as investors sold stocks in slower growing companies to invest in Internet stocks. In February 2000, Alan Greenspan announced a plan to aggressively raise interest rates.
There followed a fairly mild recession which began in March 2001, continued after 9/11, and then ended at the end of 2001. (Some economists argue that there was no recession, since the US didn’t experience two consecutive quarters of declining activity.)
Buying any time in 2000 would have been too early, and arguably even in early 2001 would have been early. But investing around the middle of 2001, 3–6 months after the start of the recession … or buying the 9/11 dip on September 12th … would have been a winning move.
Exhibit 9: “Bursting the Dot Com Bubble”
2008: the “Great Recession”
In 2008, the market peaked in October, and took a full year to lose 30%. Even buying then, in the teeth of a vicious recession, would have been a mistake …the market continued to unwind all the way until March 2009, a full 15 months after the recession began.
In that episode, a financial crisis quickly turned into an economic crisis. At that time, what began as a subprime mortgage crisis became a broader housing crisis, and then a seres of collapses of some prominent American financial institutions: Lehman Brothers; Bear Sterns; AIG; Fannie Mae and Freddie Mac.
Today, an economic crisis has led to a financial crisis … and what I saw last week, with dislocations in the Agency market (liquidations in muni bonds, and commercial paper problems) appeared even worse than 2008.
The Fed has stepped in to backstop all of these markets last week, thankfully. I personally don’t think this time around will be nearly as bad as 2008, when we seemed to be on the verge of a collapse of the American financial system.
Exhibit 10: “Great Recession”
History would suggest that when the broad stock market trades off by over 30% from its peak, it creates a generational buying opportunity. Timing that bottom is tricky, but over six prior instances that include global pandemics, wars, severe recessions and an epic depression, the window usually lasts for 3–9 months.
I personally don’t think this time will be any different.