To retest or not to retest — that is the question. Indeed, if Hamlet were around today, he may be wondering whether the broad US equity market, after posting the second-best 25-day rally on record (trailing only 2009’s), will retest the initial market low hit on March 23 of this year.1 For many investment professionals, a retest of the market bottom is a foregone conclusion. In fact, a poll of financial advisors conducted in early April revealed that 81% expected the US equity market to retest the March 23 low.2
The results of the poll are not a surprise. History has taught us that market bottoming is a multi-phase process. In phase one, the declines are sharp and fast and typically conclude amid extreme volatility, persistent selling, and a collapse in sentiment. Sound familiar? Phase two is a retracement rally, such as the one the markets are currently experiencing. Phase three is often a retest of the earlier low.
Now, you may naturally ask, has a retesting of the market low historically resulted in a new cyclical market bottom? It depends. To be candid, observing market charts and choosing initial bottoms, retracement periods and retests is a bit like a Rorschach test — open for interpretation. We observed eight recession bear markets (1962, 1970, 1974, 1982, 1987, 1990, 2002, 2008). In half the instances (1962, 1970, 1974, and 1990), the initial low proved to be the cyclical low.3 In the other half of the examples (1982, 1987, 2002, and 2009), the initial low did not hold.4
The 50/50 result was somewhat unsatisfying, but it does suggest a new market low in this cycle is not a foregone conclusion. Further, it indicates a second negative catalyst, after the initial one, might be needed to drive markets lower. For example, in 2008, the perceived lack of urgency by US fiscal and monetary policymakers in the initial aftermath of the Lehman Brothers bankruptcy caused markets to breach earlier lows.5 Events in 1990 add further proof to the hypothesis by demonstrating what happened when a second negative catalyst did not emerge. The recession of 1990, initially caused by central banks’ restrictive monetary policy in response to inflation concerns, was modest and short-lived. Without another negative catalyst, the initial bottom was not subsequently matched or exceeded.6
Figure 1: US stock returns in the three years after an initial low in recession bear markets
Regardless of the concerns investors often register about whether markets will retest lows, history suggests whether that happened or not had little impact on returns over the subsequent years. The average three-year market return from the initial low in the instances when that low held (1962, 1970, 1974, and 1990) was 56.5%.7 Surprisingly, when that initial low did not hold (1982, 1987, 2002, and 2009), the average three-year market return after the initial low was even better: 57.8%.8
Historically, at least, it has not mattered whether the initial low held or not. So, maybe it is time for investors to stop collectively obsessing over whether or not markets will retest lows.
Of course, there is no guarantee that history will repeat itself. But the past may give one confidence in that oft-quoted observation that it’s difficult to predict the direction of the next hundred points in the S&P 500 Index, but you can be more assured in guessing what the intermediate- and long-term direction of the next thousand points will be.
1 Sources: Bloomberg L.P., Standard & Poor’s, as of 4/27/20. US stocks’ performance represented by the S&P 500.
2 Source: Ned Davis Research, as of 4/3/20.
3 Sources: Bloomberg L.P., Standard & Poor’s, as of 4/27/20. As represented by the S&P 500.
4 Sources: Bloomberg L.P., Standard & Poor’s, as of 4/27/20. As represented by the S&P 500.
5 Sources: Bloomberg L.P., Standard & Poor’s, as of 4/27/20. As represented by the S&P 500.
6 Sources: Bloomberg L.P., Standard & Poor’s, as of 4/27/20. As represented by the S&P 500.
7 Sources: Bloomberg L.P., Standard & Poor’s, as of 4/27/20. As represented by the S&P 500.
8 Sources: Bloomberg L.P., Standard & Poor’s, as of 4/27/20. As represented by the S&P 500.
Blog header image: Nat Sumanatemeya / Stocksy
The S&P 500 is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States. It is not possible to invest directly in an index. Past performance is no guarantee of future results.
The opinions referenced above are those of the authors as of April 28, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.