History doesn't repeat itself, but it often rhymes.
– Samuel Clemens (a.k.a. Mark Twain)
Once you have children, one of the fun exercises is analyzing which genetic traits each parent has passed onto their child to try and figure out which of them the child looks like the most. Often you will compare their pictures to yours from when you were that age. In investments, we often do the same. Every time there is a pullback, correction, or bear market, we look to the past to find similarities or differences compared to a previous market event. We do this to get insight as to where the bottom might form, and when a recovery might happen and what shape it might take. All bear markets and bull markets, though, are like snowflakes and no two are perfectly alike.
However, as Mark Twain once said, “History doesn’t repeat itself, but it does rhyme.” While there is no proof that he said it, the quote is still widely attributed to him. Regardless, of who coined the phrase, it is still fitting when comparing different market events.
Looking at previous market events for the S&P 500 Index, it seems that a comparison to 1987 might be the best. Back then, we saw a strong rally of 46.5% from the previous low, followed by a sharp decline of 33%. It is the sharpness in the drop where the similarities are striking. While 1987 experienced a bear market in one day, on October 19, the peak of the market was actually August 25. The current market has experienced the fastest bear market from peak, falling 20% in only 18 days.
Not only does it look similar by the shape of the index rally and fall, but it also looks similar from a valuation perspective. In 1987, valuation — as measured by trailing 12-month price-to-earnings ratio — had surpassed trailing earnings by 23 times at the top of the market, a level that would suggest that the equity market was expensive relative to the 50-year average of 16.5 times. Similarly, this year, valuation hit a high of 22 times the trailing earnings, once again suggesting that the market was overpriced relative to the long-term average, as well as the fundamentals. It is not surprising that the falls from those elevated levels were similar.
No two market environments are the same, but the resemblance is uncanny.
Although the rise was similar in magnitude and length, and so far, the fall looks similar, the fundamental environments are different. There was not a recessionary environment in 1987, nor did it end up in a recession, whereas the expected drag on the U.S. economy from the containment efforts will result in a recession for the U.S. economy. And therefore, the recovery from the current bear market may be quite different.
While comparisons between today and 1987 are interesting, our key take away from the two is that, in both cases, the fundamentals were stretched. Index levels or percentage changes are essentially irrelevant to determine if the market is expensive or cheap. What is more important is looking at valuation in context with earnings and economicfundamentals. In the summer of 2019, our team was positioning our model portfolio more defensively with a 10% underweight to equities, as we could see that fundamentals were deteriorating while valuations kept climbing. We couldn’t have predicted the economic impact and bear market of COVID-19. For that matter, we can never predict these events. Hope isn’t an investment strategy, and neither is panic. That is why we stress fundamentals as an important guide to portfolio positioning. The market will always catch up to the fundamentals — to the upside as well as downside. While we may not have seen the bottom of this bear market, the equity market fundamentals are starting to look compelling.
Senior Investment Strategist
A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates.
Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.
The opinions expressed are those of Manulife Investment Management as of the date of this publication, and are subject to change based on market and other conditions. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein. Manulife Investment Management disclaims any responsibility to update such information. Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.
All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management Limited, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Unless otherwise specified, all data is sourced from Manulife Investment Management.
Manulife, Stylized M Design, and Manulife Investment Management & Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and its affiliates under license.