October 10, 2022
What to Watch - The Road to Recovery
Even after the selloff in the first three quarters, we still believe equities have more room to fall. The market needs to come to the realization that a Fed pivot is not likely anytime soon and taming inflation will ultimately require a meaningful hit to growth; both of which will require further discounting. When the dust settles and the market does find a bottom, how long will it take for the S&P 500 to recapture the previous record? Without a meaningful move down in interest rates, we believe the recovery will take time. In this week’s commentary we explore historical bear market recoveries and what it means for investors today.
Recovery Length has Varied Greatly
Recoveries can take time. Historically, over the past 21 bear markets the S&P 500 has endured since 1928, it has taken an average of 5 years for the index to recapture the previous high after the initial 20% sell-off. Looking at results from the market trough, that figure dips down to 4.5 years.
As shown in the chart below, the years to recover has varied greatly, ranging from 5 months to 25 years.
Source: Bloomberg LP, S&P
Quick Recoveries Have Been Driven by Expanding Valuations and Lower Interest Rates
Looking at all rapid recoveries (less than 3 years), two things were fairly consistent†: valuations rose and interest rates fell, helping to accelerate the market back to its previous high. The scatter plot below highlights this dynamic. With the exception of the recovery from October 1987 to July of 1989, all other recoveries of 3 years or less saw valuations increase 5% of more throughout the recovery.
Source: Bloomberg LP, note valuation data is only captured for the previous 10 bear markets
Looking at interest rates, we see a similar dynamic. Recoveries of 3 years or less saw interest rates fall 1.1% on average. Those recoveries that saw rates remain flat or increase saw recovery time increase greatly. Isolating these instances, we see the average recovery time jump to 5.4 years.
Valuation Expansion is Unlikely without Lower Rates
Given the current backdrop, we have little reason to believe that valuations will be providing support from current levels. Even after the derating we have seen this year, current valuations remain slightly above long run averages on an absolute basis and in-line when factoring in the current interest rate regime, as shown in the chart below.
Source: Bloomberg LP, S&P 500 Index, US Generic 10 Year Treasury Yield, Monthly data from 12/31/1965-9/30/2022.
Additionally, just as we have seen this year, interest rates tend to drive valuations; given the current inflation backdrop, we have little reason to believe interest rates will be moving down materially anytime soon. As such, investors should not count on a strong boost from valuations this time around to generate total returns.
Source: Bloomberg LP, S&P 500 earnings yield, US Generic 10-Year Treasury. Monthly data from 1/31/1952 – 9/30/2022. Implied PE based on 10/5/2022 U.S. 10-year Treasury yield
The Bottom Line
The road to recovery can take time. While we continue to favor hedging equity exposure in the near term, we also believe investors will need to look beyond traditional equity/bond allocations to help accelerate the recovery, when the time comes. Without a boost from valuations or lower interest rates time to recovery could be extended.
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†With the exception of May 1962-Sept 1963 with interest rates and July 1989.
The price to earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share.