• A Societe Generale study of bear markets since 1870 showed that the current bear-market rally is a departure from history.  
  • Andrew Lapthorne, the firm's head of quant strategy, concluded that investors are taking an early victory lap for the economy even after accounting for trillions in stimulus spending. 
  • He expects the stock market to end the year roughly 7% lower than current levels.  
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April was the best month for stocks since 1987. But this stand-out performance is not being universally cheered on Wall Street. 

The S&P 500's 13% ascent last month can be traced back to its bottom on March 23 — the same day the Federal Reserve essentially pledged to do whatever it takes to support the economy during the coronavirus pandemic. Even with this stimulus in action, investors declared an early victory for an economy that must still crawl out of its worst contraction in many decades, according to Andrew Lapthorne, the head of quantitative strategy at Societe Generale.  

He drew this conclusion by studying a 150-year history of bear markets, defined as a 20% decline from recent highs. 

"Beware of the oddity in this bear rally," Lapthorne said in a recent note to clients.

He added: "With the fallout from the complete shutdown of economic life in terms of disruptions in supply chains and collapse of aggregate demand, as well as the uncertainty on the post-lockdown path to recovery, new market bottoms are possible, although the unprecedented massive policy response could provide the backstop to a worsening case of deflationary spiral."

His study of bear markets since 1870 led him to conclude that the S&P 500 would finish the year at about 2,715, representing a 7% decline from its April close.

Both the crash and recovery are abnormal

Lapthorne's analysis started by including episodes since 1870 when the S&P 500's decline could ostensibly have been rounded up to 20%. One recent example was the late-2018 sell-off that winded up as a 19.6% decline.

But because the 2020 drop has been a different beast in terms of its speed, comparing it to every bear market was not empirically ideal.

And so he filtered for severe bear markets, defined as drawdowns of at least 30%, to make them comparable to this one. The roster of 15 meltdowns includes infamous sell-offs like the crash of 1929, Black Monday, and the dotcom bust. 

He found that on average, the S&P 500 recovered by 4% within a month, 13% within three months, and 27% within a year. The typical trajectory of recoveries is similar even when the Great Depression, often likened to the coronavirus crisis, is included.

By comparison, stocks have leapt more than 30% from their bottom in March.

Screen Shot 2020 05 01 at 12.42.07 PM
Societe Generale

The brisk rally of 2020 cannot be divorced from the record amount of government stimulus that flowed into the economy. On this account, Lapthorne said the market's roaring comeback is reasonable.

He inserted one more caveat into his analysis: 150 years is perhaps too long a timeframe for analyzing the recent bear market. The forces that drive stocks and the economy have evolved over the last century and a half, and so it's possible to slide into the error of comparing apples with oranges.

For this reason, Lapthorne averaged the three most recent severe crashes — in 1987, 2000, and 2008 — and then compared them to the rest of his timeframe. He still found that the post-crisis recoveries were similar to the preceding episodes, leaving 2020 as the odd one out.

Lapthorne's grand conclusion is that history is rife with many examples of bear rallies that give way to even deeper losses. He left clients with three recommendations: stay hedged with defensive assets, beware of momentum stocks that are sensitive to broader market moves, and be well-positioned for a rally in undervalued stocks.

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