The resemblance is uncanny

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.

This chart compares the S&P 500 rally in 1987 and the subsequent fall on October 19th, to the S&P 500 rally and subsequent fall this year, indexed to 100 in order to show the similarities for these two time periods.

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.

This chart shows the S&P 500 trailing price earnings ratio increase and subsequent fall in 1987 to the similar rise and fall this year. The rise and fall of both periods have a very similar pattern.

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.

Kevin Headland
Senior Investment Strategist

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Kevin Headland, CIM

Kevin Headland, CIM, 

Senior Investment Strategist

Manulife Investment Management

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Macan Nia, CFA

Macan Nia, CFA, 

Senior Investment Strategist

Manulife Investment Management

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