Reopened economies around the world are continuing to grapple with resurgent COVID-19 cases in August and September, as governments in various regions were compelled to return to partial shutdowns or various restrictions. However, on a more positive note, it seems here at home in the U.S. that cases, fatalities, and hospitalizations are once again trending lower.
Rallies in riskier assets such as stocks and high yield bonds throughout the summer months have appeared to ignore and possibly underestimate the depth of economic damage and risks of successive waves of infections restarting a suppression of economic activity. Despite this under appreciation for unemployment and corporate defaults, the market has melted up to new all-time highs.
It took only 33 days for the S&P 500 to fall approximately 34% from its highs back in February of this year. This was one of the fastest drops of this magnitude in recorded history, and the S&P 500 has now rebounded and rocketed back up to new all-time highs in just under 150 days.
To put into perspective just how quick this all happened, we wanted to compare this extraordinary drop and recovery to all the other bear markets since the 1950s.
Shown above in the table we can see the average length of a bear market drop during both times when there was a recession determined after the fact and when there was a market drop without a serious economic event. The average time from a market top to a market low during recessionary periods was 18 months, and the subsequent time for the market to recover was 24 months!
While the percentage decline this time around (-34%) was similar to the average of all of the other recessionary environments (-37%), the length of the drawdown and eventual recovery happened in almost the blink of an eye compared to the long drawn out drawdowns and recoveries of the past.
Another widely followed market index is the NASDAQ Composite. It is a market-capitalization weighted index of companies listed on the NASDAQ exchange consisting of mainly technology, communication services, and consumer discretionary stocks. With such a large allocation to technology (40% of index), it is no surprise the top ten holdings make up a significant portion of the assets (roughly 46%). For comparison, the percentage of assets in the top ten holdings for the S&P 500 is 28%.1
Like the S&P 500, the NASDAQ Composite recovered from its lows hastily, but it only took about half the time (76 days) to reach new all-time highs compared to the S&P 500. More recently though, the index has been experiencing a little bit of nausea and has fallen close to 10% off its highs as of September 11th.
Since the inception of the Nasdaq 100 back in 1985, there have been 38 prior 3-day declines of 10%+ for the index. As one might guess, many of the 3-day drops of 10%+ for the index occurred during the Dot Com bust in 2000 and 2001. Furthermore, controlling for instances within a 50 trading day window as to eliminate multiple occurrences that happened too close together, forward returns have still been surprisingly positive.2
Below is a table from Bespoke Investment Group highlighting the forward returns after 3-day drops of 10%+.
Source: Bespoke Investment Group – Nasdaq Falls 10% But Still Above 50-DMA
Beyond the market pullback, the Federal Reserve shifted from targeting inflation at 2% to now targeting “inflation that averages 2% over time.” Simply put, periods where inflation is above 2% will now be consistent with this new definition of long-run price stability.
After the news came out the bond market saw the biggest reaction, as the 10-year Treasury yield rose slightly to 0.74%; however, the new initiative largely seemed priced in as the 10-year Treasury yield fell back towards 0.67% as of September 11th.3
1 Morningstar Direct; 2 Bespoke Investment Group; 3 FS Investments – Meet the new Fed policy: Low interest rates for years to come
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