“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” So said Sir John Templeton, describing sentiment’s evolution throughout a bull market. This bull market, which began on March 23, was certainly born on pessimism—and sentiment hasn’t much improved in the past seven months as investors fretted a litany of alleged negatives, including shaky corporate bond markets, wildly fluctuating oil prices, the expiration of some CARES Act benefits and more. Yet through it all, one fear has remained a pulsating constant: a new global COVID flare-up triggering a second wave of worldwide draconian lockdowns. However rational this fear may be, in our view, its very existence doesn’t mean a new bear market looms. It is normal for investors to fight the last war, so to speak, throughout a bull market. That they are doing so today is a sign sentiment is charting its normal course—a bullish development.
In our view, it is true this year’s earlier lockdowns triggered the February–March bear market as investors came to grips with the resulting sharp contraction in economic activity. Stocks previewed what would become the sharpest, deepest economic decline on record. The S&P 500’s -33.8% fall from February 19’s record high through March 23 reflected stocks anticipating the ensuing global recession and then some—all in just under five weeks, the fastest bear market ever. [i]
But it wasn’t just the impending economic damage that hurt stocks—it was the sheer surprise that resulted in a rapid reassessment of future earnings. The pandemic struck when the global economy was strong, with many expecting ongoing growth. Heading into 2020, analysts estimated S&P 500 Q1 and Q2 earnings would rise 5.0% y/y and 6.6%, respectively, with a full-year forecast for 9.6% growth from a 5.4% rise in revenue. [ii] As economies globally began locking down, it became clear to stocks that for the first time in modern memory, governments would mandate a cessation of most economic activity. That surprise was what triggered panic. Stocks were forced to reckon with the mass destruction of earnings and revenues on a broad, global scale. By June’s end, Q1 S&P 500 earnings—officially down -14.9% y/y—confirmed some of the damaging economic fallout stocks had digested several months prior. [iii]
However, we don’t think the existence of negatives alone is enough to keep stocks down—they must have surprise power. That is true whether or not the alleged negative is the same issue that caused the bear market. This is because markets are efficient, in our view, moving ahead of widely expected events and discounting widely known information as soon as it becomes available. Headlines globally have hyped prospects for a second COVID wave and renewed lockdowns for months. Pundits have warned future COVID flare-ups could mirror the 1918 flu pandemic’s second wave. Health experts project a surge of COVID cases in the upcoming winter months, and every new restriction in Europe prompts a round of dire warnings. As some debate the societal factors contributing to the virus’s resurgence in certain areas, others worry about COVID mutating into a more virulent strain. All these possibilities—and more—circulated when the first wave was still raging.
We acknowledge a possible second COVID wave could pose a risk to stocks if it morphs into something much bigger and worse than what investors have already reckoned with. For example, a return to widespread, full-scale national lockdowns around the world could sow panic among investors. The difficulty with assessing this possibility is that lockdowns are political decisions, which defy forecasts.
Thus far, most governments have resorted to targeted restrictions rather than full lockdowns. In the US, for example, California is implementing new restrictions, while Florida is now mostly open. Across the Atlantic, parts of the UK face tiered restrictions depending on COVID severity. On the Continent, the Spanish national government ordered a 15-day state of emergency in Madrid, while French officials declared a public health emergency and mandated a curfew in Paris and eight other municipalities. Besides these restrictions, we can’t predict how local populations will react. Will people tire of the measures and be more willing to defy orders? That, in turn, could trigger a harsher government response—which could then panic markets. However, we think investors have to assess these developments as they evolve rather than act now based on a potential outcome, since markets move most on probabilities, not possibilities. So, we are monitoring how leaders both in the US and abroad handle flare-ups in the meantime.
This isn’t the first time investors have hunted nonstop for a repeat of what caused the preceding bear market. In the 2009–2020 bull market’s first several years, investors were constantly on the lookout for the seeds of a new financial crisis. In 2010, Meredith Whitney—a Wall Street analyst many hailed for forecasting 2008’s meltdown—gave a 60 Minutes interview warning about impending municipal bond turmoil, which never materialized. Neither did a student-loan, subprime-auto or debt-ceiling crisis, all of which were rumored to be the genesis of a second financial crash at various points. Looking a bit further back in the annals of bear market causes, to this day, people search for signs of a repeat of the dot-com bubble. Over the last decade, many worried 2000’s euphoria would erupt again, pointing to high-profile Tech IPOs, small biotech companies or “overvalued” Big Tech firms as evidence. None stopped the bull market. Lately, many see special-purpose acquisition companies (SPACs) as the return of IPO mania—another manifestation of this fear.
We think the prevalence of past bear market fears—whether another speculative crash, financial crisis or pandemic shutdown—is typical of young bull markets. Scarred by recent chaos and confusion, it is entirely normal for investors to see threats (real or perceived) behind every market wobble, waiting to strike again. But extrapolating past events into the future is a common behavioral investment error known as recency bias. Stocks care less about what just happened and more about the economic and political conditions in the next 3–30 months. Rather than fixate on the recent past, we think investors benefit most from looking forward like stocks do—and remembering markets move most on probabilities, not possibilities, with surprise generally the biggest swing factor.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[i] Source: FactSet, as of 10/06/2020. S&P 500 total return, 02/19/2020–03/23/2020.
[ii] Source: FactSet, Earnings Insight, as of 01/03/2020.
[iii] Ibid., as of 06/26/2020.
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