Fast and/or Furious?

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“If you wish to see the truth, then hold no opinions for, or against, anything” – Third Chinese Patriarch of Zen

The COVID-19 market crash and subsequent recovery has been atypical of previous recessions. Government lockdown brought economic activity to an abrupt standstill, but reopening as well as the fiscal and monetary response were just as decisive. In just a little over a year from lockdown, economic activity in the U.S. is expected to have exceeded pre-pandemic levels this past June and equity markets are well above pre-pandemic highs. This V-shaped recovery has the market running at a torrid +45% per annum rate since March 2020, with the S&P 500 up a robust +65% from its March 2020 close. Despite elevated unemployment in the U.S., many are warning of speculative “bubbles” based on the rapid rise of stretched valuations.

While the current market rally is impressive on its face, this month we look at historical trough-to-peak rallies to see how the current market compares with previous cycles.

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Fast and/or Furious?

“If you wish to see the truth, then hold no opinions for, or against, anything” – Third Chinese Patriarch of Zen

The COVID-19 market crash and subsequent recovery has been atypical of previous recessions. Government lockdown brought economic activity to an abrupt standstill, but reopening as well as the fiscal and monetary response were just as decisive. In just a little over a year from lockdown, economic activity in the U.S. is expected to have exceeded pre-pandemic levels this past June and equity markets are well above pre-pandemic highs. This V-shaped recovery has the market running at a torrid +45% per annum rate since March 2020, with the S&P 500 up a robust +65% from its March 2020 close. Despite elevated unemployment in the U.S., many are warning of speculative “bubbles” based on the rapid rise of stretched valuations.

While the current market rally is impressive on its face, this month we look at historical trough-to-peak rallies to see how the current market compares with previous cycles. For our analysis, we collect monthly data from 1900 onwards, and do not collect intra-month highs and lows, which could lead to different results. The table below sets forth every monthly market decline of -10% or greater since 1900, as well as the magnitude of the subsequent rally to the next peak (prior to the following -10% or greater drawdown). 


Source. Reuters, Orthogonal

The data shows that the average market gain to the following market peak is +133%, and that removing the top and bottom outliers (trimmed average) still results in a robust +93% gain. The current market’s gain of +65% is well below the historical average and just above the median of +55%—not out of the ordinary, as can be seen in the chart below. 
Source. Reuters, Orthogonal

Next we turn to all monthly market declines of -5% or greater since 1900, and measure subsequent rallies from the trough to the subsequent peak.


Source. Reuters, Orthogonal

The table above shows that it is quite common to see prolonged rallies with magnitude around +55% without even a -5% drawdown in between. As expected, however, the average magnitude of the rally prior to a -5% drawdown is much lower than in the case of -10% drawdowns. Below we show a chart of where the current rally stands in comparison to these -5% peaks and troughs.


Source. Reuters, Orthogonal

While the pace of the current market recovery/rally is extraordinary, its magnitude does not stand out as stretched in comparison to past market recoveries. To the contrary, it remains below average in comparison to historical -5% and -10% peak-to-trough cycles, and just slightly above median for the same.

It may be true that valuations are “stretched” by historical standards, but the magnitude of the market’s rally from March lows is hardly anything out of ordinary and could well continue to extend for some time.