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My short answer to the question posed in the title here: A typical market bottom doesn’t really look much like what the US equity market experienced in June 2022, at least not historically speaking. Let’s consider the evidence.
Amid the S&P 500 Index’s recent (and, as of this writing, still-ongoing) rally, I’ve been fielding a lot of questions around whether or not the US market may have reached its 2022 low this past June. I’ve been inclined to think not, along with many other observers, but the market has clearly been testing that assessment over the last few months. With that in mind, I decided to turn to market history in search of some guidance on the matter.
I updated a prior analysis, focused on key factors — market volatility levels, inflation rates, price/earnings (P/E) ratios, credit spreads, and market drawdowns — that have historically been correlated to US equity market bottoms. Based on this model, which included the 22 US market bottoms since the late 1940s (Figure 1), the hypothesis that June 2022 may have marked this year’s bottom seems unlikely.
My analysis examined every time the S&P 500 went into a “downtrend” over the past 70+ years. Then, for each month within such a downtrend, it looked at the different factors cited above to determine the probability that the US market had in fact bottomed at that month-end. With the caveat that attempting to extrapolate the results to the current market environment is hardly an exact science, there were some interesting takeaways for equity investors.
Historically, in rank order, here are a few potentially telling indicators of a likely market bottom, vis a vis today’s market setting:
The five lefthand colored columns in Figure 1 highlight “z-scores” on these metrics (where high/green = higher probability of a bottom). The next column shows the probability of that particular month-end being the market bottom from a regression-based model. All previous bottoms had a 10%+ probability, with a norm in the range of 20% – 30%. Today’s odds are only around 5%.
To recap, using the approach described above, my overarching base case is that the US equity market has not yet found a near-term bottom. Essentially, while volatility certainly rose significantly in the second quarter, setting the market up for a tactical rally, it was still not enough to offset persistent headwinds from high market valuation and lofty inflation.
If you’re wary of relying on a quantitative model to make this assessment, the right-hand columns of Figure 1 show a simple alternative framework. The vast majority of market drawdowns ended when either: 1) the US economy was already in recession; or 2) the US Federal Reserve (Fed) had already cut interest rates. Exceptions to this rule involved either very little credit spread widening (1962, 1978, 1994), or the Fed backing off from hiking rates soon after the market had bottomed (as with the 2016 rate-hike pause and the 2019 policy “pivot.”)
These conditions are not in place right now:
1) While slowing to some degree, the US economy remains in pretty strong shape overall;
2) The Fed is continuing to raise rates, with no near-term prospect of a policy reversal; and
3) Investment-grade credit spreads have nearly doubled since the fall of 2019.
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