Why There's Little Point In Asking Whether The Stock Market Will Retest Lows

Summary

• For many investment professionals, a retest of the market bottom is a foregone conclusion.
• History has taught us that market bottoming is a multi-phase process.
• Has a retesting of the market low historically resulted in a new cyclical market bottom? It depends.

By Brian Levitt, Global Market Strategist, North America, and Talley Léger, Senior Investment Strategist

In past downturns, how often the market revisited or surpassed bottoms had little impact on future long-term returns.

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

Source: Bloomberg L.P. All data are represented by the S&P 500 Index* - as of April 27, 2020. Performance quoted is past performance and cannot guarantee comparable future results.

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.

Important Information

Blog header image: Nat Sumanatemeya / Stocksy

Index definitions:

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.

Why there’s little point in asking whether the stock market will retest lows by Invesco US

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Comments

[M Elan]

I wondered when somebody would compare charts to Rorschach tests

[David Alton Clark]

Just FYI for anyone reading this article. The proper technical term if the market were to fall back to low for the first time is "TEST" the low. You can't "RETEST" the low if you haven't "TESTED" yet.

So ever time they say will the market "RETEST" the low is flawed. First the market would have to test the low, which it hasn't. I think they believe they are talking about testing the low... but are making a novice mistake by referring to this development as "RETESTING" the low.

Just FYI is case anyone was confused. This is a common mistake many people make. DAC

[User 50009295]

I see what you're saying, but I disagree. Perhaps it's the way the author stated it: "a retest of the market bottom". That's probably not the best way of stating it since technically there is no market bottom. But someone could say that they believe the market will retest 2191. The first time the market came to that price was I believe in 2016. So, this was the initial test of that level and the market went through it with very little resistance. The market then retested that price during the current sell-off and held. This is our new support level for now. And obviously some market participants believe we will retest that level again.

[Unojack]

@David Alton Clark Agreed but also Potato/Potato, a matter of pronunciation not starch content. :)

[David Alton Clark]

you are correct! If the author had referenced one of the lower levels from a few years ago I’d agree with you. But he didn’t. And they actually in the article reference the March 23 low as the initial low. So you need to go back and read the article more carefully and then you’ll understand why I made the statement I made. So you get a point for your catch but then I win the game because the author in this article specifically says he’s talking about the March low as the initial low. I’m willing to call it even though take it easy! see below or read article again. DAC

“rally on record (trailing only 2009's), will retest the initial market low hit on March 23 of this year.1 For many investment”

[gdepommereau]

The logic of this article is flawed. What matters is not the past, it is the present. Today, the stock market is high and has rebound from the mid March lows, while the economy is diving deeper towards a massive recession. Q1 results and statistics have only captured the Covid impact of the last 2 weeks of the quarter. Q2 will have a full 3 months of horrible financial results with numerous bankruptcies, and a future becoming ever more gloomy. The V shape recovery is clearly not going to happen since the "back to normal" situation is pushed back each week as the virus proves to be more difficult to eradicate. 2nd wave of pandemy is happening in some countries and could hit Europe and the US again. Entire sectors are moribund (airlines, aerospace, travel, restaurant and hotels, real estate,...).
So how on earth can the financial market be so blind as to only look at expected 2021 theoretical "normality" ? And no amount of Central Banks "easing" will compensate for the lost activity for so long. So brace for a hard fall !

[Dale Roberts]

On Twitter this morning I saw a chart on the history of correction and recovery. @Invesco US

I'm @67Dodge on Twitter.

The chart used All Bears (average) and lower bound and higher bound and severe market corrections. The current violent up and down looks like nothing even close to any of the above.

Chart is from SG Cross Asset Research.

All said, markets have also never seen this level of fiscal support or life support make that. They've offered limitless support.

Dale

[Phitto]

I wonder how you decide what the 'initial low' is? For example in 2000-2002 the S&P lost (roughly for all the numbers I post) 30% within 7 months, then it went up by about 20% within 2 months, then it lost another 25% within 4 months, then it gained another 20% within 3 months, then it lost another 30% within 6 months, gained 20% within 2 months and finally lost another 20% within roughly 2 months until it reached the final low.

The same is true for most of the other time frames on your list.

You can't talk about the economic definition of 'trough' either, so I wonder how you come to your conclusions and why you think that we have necessarily reached some kind of 'initial low' or 'trough' at the end of March?

Personally I don't think looking at previous recessions makes sense anyway. Each recession is different and you can't really predict how this will pan out. It's like looking at the stock price from previous years to predict what the stock price will be in the future.

[Purpose_trader]

no two recessions are the same, if people continue to watch the grim numbers of infections and deaths on the mainstream media, people will continue to hibernate in fear, the economy will continue to shrink and the stock market will follow. in my view, this will be the main factor in determining whether or not we retest the 23 march lows.

[Vinci1452]

perfectly said....in the previous recessions, especially 2008, the 'problem'...a real estate bubble ...was 'fixed' by the Bush team and it was up up away...albeit a long slow slog....with this situation, its a virus...creating fear...less shopping, no sports stadiums, less flying, less dining, less travel, less EVERYTHING...... and with a country(and world to be fair) which can't even produce enough simple cheap N95 masks to protect the hospital workers or the elderly or anyone else who desires one...(but we seem to spit out excess aircraft carriers and worthless missiles by the millions to fight whatever fictitious 'enemy at the gates' national security threat du jour).....there is simply no way we are out of the woods til a vaccine.....notwithstanding the 'liberate' crowd....for no matter how the politicians at MSM CNBC FOX spin this, the world economy will be running near zero or negative GDP for a couple of years....

retest or not retest...it will be a lousy market and economy either way....forget the 'V'.... lucky its an 'L' with some little 'W's....trade fibonacci accordingly if you already have enough saved.....heaven help those with little savings or who live paycheck to paycheck...

[navyair]

@Purpose_trader Concur. Especially given that a lot of the wealth resides with older Americans, they won't be creating demand, buying new vehicles, taking cruises, etc. until this CV-19 has been resolved. Certainly not in normal demand #'s.

Plus, for the under/un-employed Americans, it will take a year or two to dig out from two months out of work. One possible positive is that even though this will cause a slow down of buying "stuff" which would re-ignite the economy, it may force many folks to reassess their savings for emergencies and retirement which should portend good things for the stock market down the road.

Have a great week out there, sir.

[MAYHAWK]

Actually this "older American" will be buying a new car this year given the low prices and deals to be made, also a new 4k tv. I will start traveling as soon as I can actually go somewhere without being quarantined 14 days upon entry. I have continued to live my life the same as before this insanity with the only restrictions being those imposed by the tyrants we elected in Illinois.

[jackversloot]

A good read and I wondered the same thing myself over the last week or so. Very timely.