Bullish! But Not Because of Arbitrary Bounces

One week on from stocks’ ascending 20% above last October’s low, the chatter over this alleged milestone hasn’t died down. Daily, we see headlines mulling whether this marker makes a new bull market official. Some say yes, pairing it with the traditional -20% threshold for a bear market. Some say no, pointing out the fact that some bear market rallies have exceeded 20% before giving way to new lows. We are more inclined to think back to one year ago this week, when stocks officially entered bear market territory, stirring up much of the same what happens now? debate. And it all highlights two timeless truths: Past returns don’t predict the future, and there is no all-clear signal for stocks.

Let us rewind now to June 13, 2022, the date the S&P 500 and MSCI World officially fell into bear market territory.^[i] Inflation was still accelerating. It would peak that month, but the high wouldn’t show in the data until July, and the fact that it was the high wouldn’t be clear for several months more. Most analysts anticipated the Fed would hike rates by 0.75 percentage point at its June 16 meeting, which it did, speeding up its tightening cycle and heightening recession fears. Oil prices had just flirted with their early-March highs and sat around $125 per barrel.^[ii] European natural gas prices were climbing anew. US GDP was contracting for the second straight quarter, although that also wasn’t reported until July.^[iii] Headlines coast to coast wondered how much lower stocks would go. The bear market seal was broken, so surely it would get worse!

Except stocks didn’t sink much from there. They wobbled around the low, then staged a rally in July and the first half of August. A big one. Almost 20%! Headlines’ tenor quickly shifted, with many arguing the bottom was in and a new bull market was underway. We saw studies arguing rallies that big meant falling to new lows was quite unlikely. Sure enough, what increasingly looks like the final drop was still to come in early autumn. But it still wasn’t hugely lower than June’s mark. Stocks reached their low on October 12, with the S&P 500 Total Return Index down -24.5% from its early-year high and the MSCI World Index down -26.1%.^[iv] Not fun, but also nowhere near as bad as the epic declines many anticipated when stocks first breached -20%.

Another rally began the next day. There was no announcement. A bell didn’t ring. A starting gun didn’t fire. But unlike July and August’s sucker’s rally, the autumn upturn didn’t spark hope. Instead, burned by the summer fakeout, pundits argued it must be another bear market rally. And with the Fed still hiking, Europe still dealing with natural gas supply concerns and a rising risk of recession, inflation still too high and widespread US recession forecasts, stocks would surely resume falling before too for long. To us, it all looked like the pessimism that normally reigns at bull markets’ beginnings. So did the “L-shaped recovery” chatter that picked up when the rally seemed to pause for a spell in the winter. And the fears erupting from March’s regional banking issues. And the springtime handwringing about the relatively low percentage of S&P 500 constituents participating.

In our view, this pessimism was the best clue that the recovery would have legs. We love quoting Sir John Templeton’s depiction of bull markets’ psychology, and we will do it again: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” The world hasn’t been perfect these last eight months. Far from it. Economic data worldwide are mixed at best. Germany and the overall eurozone are in a recession, by one common definition. Wage growth hasn’t matched the steep rise in living costs pretty much anywhere. Tense politics are fraying everyone’s nerves. S&P 500 earnings are in the red. But for stocks, what matters is that expectations were even worse. When the majority of economists projected recession in the US, UK and eurozone, mixed data become a pretty darned positive surprise. Those tense politics mask gridlock, which reduces legislative risk—as it nearly always does in US presidents’ third years. Earnings were weak but better than expected and revenues held up ok, helping investors anticipate a turnaround as businesses got their costs in check. US inflation hasn’t slowed as quickly as some would like, but it is no longer close to double-digit territory. As for rate hikes and bank failures, banks overall are still lending, supporting continued growth.

When an ok reality beats awful expectations, the positive surprise propels stocks up the wall of worry. That is how new bull markets are born and grow. And it is why we think this looks more and more like a new bull market, although we can’t know that for sure—20% up threshold notwithstanding. If it is, and the first leg is now behind us, remember: To capture it, you had to be ready and willing to own stocks when fear was at fever pitch—when you might not have wanted to, when headlines were warning of far worse in store. The cost of not doing so, of waiting for clarity—whether from some arbitrary 20% threshold, stocks’ return to past highs or something else—is missing returns that could compound not only through the rest of this bull market, but over your entire investment time horizon.

Yet from here, the most important thing isn’t to congratulate yourself on capturing the initial rebound if you did so. Nor is it to lament spilled milk if you didn’t (though, we hope you will file the lesson away for next time). Rather, it is to look forward and assess what comes next without letting past performance dictate your expectations. We are bullish and optimistic about what is in store immediately ahead, but that isn’t because stocks are up 20% from the low. Rather, it is because sentiment, though improved enough for several observers to acknowledge the bull market, remains pretty skeptical in the face of a pretty ok reality. Fed fears still reign supreme. Inflation fears have just migrated from the US to the UK and eurozone, where people anticipate many more aggressive rate hikes are in the offing. Many economists still forecast recession, having only delayed their projected downturns rather than revising them up. Very few people concede that all reality needs to do is beat these very meager expectations, and fewer still recognize the bullish power of gridlock, as Fisher Investments founder and Executive Chairman Ken Fisher highlighted in his new column for the UK’s Telegraph today.

So whether or not you have participated in the recovery to date, we think there is still more ahead—growth you will likely need to capture if your long-term goals involve earning market-like returns, whether for retirement or another purpose. The 20% milestone isn’t a stop or a start. It is just past returns and an arbitrary marker. It isn’t predictive, and stocks should keep looking forward, pricing in the gap between expectations and the likely reality over the next 3 – 30 months.