Lessons Learned From The Last Bear Market
It was only 30 days ago that markets were hitting all-time highs. On February 19th the S&P 500 posted a record close of 3386 and the U.S. equity markets were downplaying any real threat by the COVID-19 situation in China. However, that quickly changed, which led to the fastest market correction (decrease of 10% from recent all-time highs) anyone has witnessed. Now, as of Thursday’s close, the S&P 500 is down 28.5% and we find ourselves in the midst of a bear market (20%+ decrease from all-time highs).
We have written in previous market updates, and through special communications to our clients, about how to take advantage of the market selloff, but now we will focus on what type of stocks post great returns coming out of a bear market. This is not to say we think we are in the clear, a typical bear market will push the broader index down about 30%, but we would not be surprised to see the S&P 500 drop from these levels. At the end of 2008, the forward price-to-earnings ratio of the S&P 500 dropped to 12.6x and we very well can come down to that multiple; right now, we sit at 14.4x this year’s earnings estimates.
At our last investment committee meeting, we discussed some of the lessons that were learned coming out of the Great Recession. There were several, but the most important one is counter intuitive, so it is worth highlighting. Most investors are aware that markets are a leading indicator; in other words, they drop in anticipation of an economic slowdown and begin to recover while the economy is still in a recession. That is exactly what was observed during the last bear market; the S&P 500 bottomed at 666 on March 6th, 2009, while the economy was officially out of a recession June 2009. However, the National Bureau of Economic Research (NBER) made the announcement that the recession was over on September 20, 2010[i] That was 18 months after the market had bottomed and stocks had rallied 67% from the lows.
While stocks are falling, it is common for investors to seek companies that are perceived as “safe” such as those found in the Consumer Staples sector. Stocks you might recognize here are Clorox and Proctor & Gamble. The thought process is that these stocks will not get crushed because people will still purchase typical household items produced by these companies. The logic seems fine when looking at it on its own, but when you combine the fact that markets are forward looking, the logic falls apart. That is because the markets will bid up the price of Consumer Staples when the economy begins to look shaky and markets are making new highs, and when things look the worst in the economy, like it did on March 2009, the markets will no longer favor these stocks because it will begin to price in a recovery. It is a bold move and very difficult to begin to buy stocks that have been hit the hardest in a downturn, when it seems like you cannot see the light at the end of the tunnel. However, that is exactly what must be done. Coming out of the Great Recession we took a more cautionary stance, when we should have been more aggressive. That was a lesson for us and we have adjusted our strategy during this market downturn.
As you can see on the chart below, the Consumer Staples sector (green) trailed the S&P 500 (white) and the Information Technology sector (pink) 12 months after the March 2009 bottom. The right investment strategy was to buy growth or quality companies that have been hurt the most and avoid the “safe” Consumer Staples stocks.
The same thing happened during the recovery after the dot.com bust. The chart below shows the Consumer Staples sector (green) under performed the S&P 500 (white) and the Information Technology sector (pink) one year after the October 2002 bottom.
We don’t expect this recovery to be any different from the dot.com bubble or the Great Recession. That is why we have been actively making portfolio changes from stocks that have weathered the storm fine to companies that have been hurt the most and unjustifiably punished more than their fundamentals warrant.
It is sometimes uncomfortable for clients to see us pair down on stocks that have done well over the last couple of months, such as Clorox, in favor of companies that have been hurt by COVID-19, like ServiceNow. The chart below shows the big price increase for Clorox (pink) and the big price decrease for ServiceNow (white) during the COVID-19 scare.
Over the last two bear market recoveries, technology sector companies, like ServiceNow have outperformed the S&P 500 and consumer staples companies, like Clorox, have under performed. Clorox has benefited from the buying frenzy to the point that Clorox wipes cannot be found at stores anymore; sure this will benefit their earnings over the next few quarters, but it is unlikely that people will continue to hoard Clorox wipes for the next few years. Therefore, the price of the stock will not continue to increase at its current pace. ServiceNow on the other hand, is a company that has a focus on workflow automation, data consolidation, and administration of business processes. People working remotely will not be a one-time event; this will be the future and companies like ServiceNow are setup to help businesses put a plan in place to prepare for the workforce of tomorrow.
This is just an example of the many things we are doing today to take advantage of the opportunities that the markets are now making available. We have and will continue to make adjustments to our strategies to put our clients in a better position coming out of this bear market. We thank you for your trust in our team.
Surevest clients and employees may own some or all the stocks mentioned. This article is for informational purposes only and not meant as specific financial advice. Clients and employees of Surevest own shares of all companies mentioned. This is not a recommendation to buy or sell any securities. Speak with your financial advisor before making any investments or acting on any topics discussed. Surevest Private Wealth is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Surevest Private Wealth and its representatives are properly licensed or exempt from licensure.