Markets will see plenty of rallies, but history suggests the real bottom will be at least 2 years away

Our pH Report Sentiment Index continues to prove its value as the chart shows. It has correctly signalled a downturn since its December launch, just ahead of the S&P 500’s final peak at 4800 versus 3700 today. It is still negative today.

Amusingly, most of the people who told us we were wrong, and “didn’t know what we were talking about”, are still doing the same job. And they are mostly busy forecasting a quick bounceback. But as my former editor at the Financial Times notes:

“Investors who decide that the sell-off is a time to buy, should do their homework. Those who want to spend less time managing their investments might be more comfortable in less tricky waters.”

As the chart shows, based on Nobel Prize-winner Prof Robert Shiller’s CAPE Index, the Fed’s stimulus programme took valuations to the second-highest level in history:

  • They were a long way above 1929 valuations
  • Last year’s peak valuation was only exceeded by Alan Greenspan’s 2000’s dotcom bubble
  • Even the 2008 subprime bubble “only” took valuations to the 1966 and 1901 levels

Logic therefore suggests, that we need to look back at history if we want to “know what happens next”.

The chart shows the percentage change in the S&P 500 for the period 1928 – 1932 and 1998 – 2003, versus the 2020 – 2022 performance to date:

  • It starts 300 days before the actual peak, to provide perspective
  • The 1929 downturn had the most dramatic rise and was up 64% by its peak
  • The 2000 downturn, by comparison, was up just 22% over the final 300 days
  • The current downturn was in the middle, up 38% before the final peak

Today, of course, what really matters is “what happens next”. And what the history of the 1929 and 2000 downturns tells us, is that it takes a long time for stocks to bottom.

Effectively, the market has to “wash out” the effect of the euphoria that took it to the peak. And so it has to destroy the dreams of all the people who hope that recovery might be ‘just around the corner’.

There will be lots of ‘false dawn rallies’ along the way. But, as Farrell’s Rule No 4 says:

“4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.”

  • In the 1929 downturn, the final bottom took place 678 trading days later
  • By then, the S&P 500 was worth just 23% of its peak value
  • In the 2000 downturn, it took 637 trading days to reach the final bottom
  • By then, the S&P 500 was worth only 62% of its peak value

And, of course, the real 2000 bubble had been in the NASDAQ, which lost 78% of its value.

This suggests the real pain is yet to come. Housing markets look terribly over-valued around the world, as I noted last month. And US consumer sentiment is at all-time lows. So most company earnings seem set to fall, with more than 60% of US CEOs now expecting to see a recession.