History may rhyme for stocks, but it doesn’t repeat
by Dr. Brian Jacobsen, CFA, and John Manley, CFA, Wells Fargo Asset Management
Mark Twain reportedly said that history doesn’t repeat, but it does rhyme. It’s easy to try to look at charts of the market and try to find similar patterns in history. Sometimes that pattern-seeking can be illuminating, but it can also be misleading. Looking at the patterns of the stock market since May 21, 2015, has helped reveal a few important lessons and perhaps provides some decent guidance going forward.
First, as we pointed out in our previous blog post about market corrections and recoveries, corrections are typically driven by one or more of three things:
- Fears of impending economic slowdowns
- Fears of inflation—or, now, deflation
- Fears related to politics, whether it’s war, embargoes, or Brexit
We believed the correction that started on May 21, 2015 was driven by fears about what a stronger dollar and lower commodity prices would do to economic growth. The fears were similar to those that triggered the 1953 and 1984 market corrections. But the 2015 correction played out differently: It rhymed without repeating. In 1953, at this point, the S&P 500 Index was 20% higher than its previous peak. In 1984, it was 14.5% higher.
Part of the problem in 2015 was that—while the market turned and recovered going into November—the underlying fears were amplified, not dealt with. So the market turned south again, culminating in a double-dip correction. Double-dips are rare and scary. In 1956 and 1976, they were harbingers of bear markets or protracted periods of meandering markets.
But 2015 didn’t turn out to be a bear market. Instead, we passed the previous peak. We think there are two big reasons the market rebounded:
- China’s currency policy is less opaque than it was in 2015. The market drops in August and November were triggered by a significant depreciation of the Chinese currency. Over the past few months, the yuan has been depreciating without the same adverse results. Why? It helps that the Chinese government is more transparent about what it is trying to do with its currency. In August and November, investors were forced to let their imaginations run wild with why the yuan was depreciating. Now it’s a bit clearer: While the yuan can depreciate relative to the dollar, it’s been remarkably stable relative to other currencies. Untethering the yuan from the dollar is part of the long process of letting markets, more than government fiat, determine economic outcomes.
- The data just hasn’t been that bad. China’s economy appears to be stabilizing with its growth transition. The U.S. economy’s leading economic indicators—low initial unemployment claims and good Institute for Supply Management manufacturing and nonmanufacturing numbers—are pointing to growth, not decline. The first quarter of 2016 will likely prove to be the low point for quarterly earnings. It’s hard to get bearish when earnings are likely to grow rather than shrink.
From a purely pattern-seeking and storytelling perspective, the S&P 500 Index has been tracing out a pattern most similar to the pattern that traced out beginning on June 16, 1977, and June 24, 1998. This finding depends on whether you trace out the pattern beginning at June 21, 2015, or November 3, 2015 (the recent peaks prior to the corrections). If market events were to play out like 1998, then there’s likely 40% more upside. If events were to play out like 1977, then maybe it’s closer to 7%. Both of those figures are based on the peaks the market hit after June 16, 1977, and June 24, 1998, but before the S&P 500 Index’s marked turndowns.
We think events will play out like neither of those instances and investors need to simply pay close attention to the data rather than the charts. Assuming the market’s historical pattern will play out again is a mistake, but learning a lesson from history isn’t. Charts can be pretty and serve as a rough guide, but you need to know the underlying narrative behind why the charts look the way they do. The underlying data are different today than they were in 1977 or 1998, or in any other time period for that matter.
Unless the Federal Reserve tightens quickly—which we think is unlikely—there is still a lot of money that’s either seeking out or sitting in low- or negative-yielding assets. As low interest rates persist, people likely will try to push that money toward riskier assets, such as stocks, and push them higher. We think economic growth will prove to be resilient and earnings will continue to rise. While investors may be fickle in how much they are willing to pay for earnings, we think those who William Safire would have called the “nattering nabobs of negativism” will have to throw in the towel in the face of stronger data. Sure, they haven’t so far, but at least fewer and fewer people are listening to them.
History might rhyme, making the market’s new highs old hat again.
Copyright © Wells Fargo Asset Management
