Has Has Has

Has a long and painful journey to the bottom in equities just begun?

Equities 8 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  S&P 500 is down 18% and we are 95 trading sessions into the current drawdown. Investors basing their decisions today on the experience of the past 12 years would argue that now is the time to buy equities, but unfortunately the past 12 years are worthless for the decision making today. The two drawdowns of the 1970s and one post the dot-com bubble are more aligned with the current dynamics and based on these three drawdowns investors are in for more pain and for much longer than most expect will happen.


History suggests the current drawdown could be long and brutal

The current drawdown feels brutal with Nasdaq 100 down 28% and S&P 500 down 17% since their respective peaks. We are 95 days into the current drawdown in S&P 500 and a drawdown that is currently the 15th largest since 1928. As we wrote the other day, many strategists and investors are talking more about buying the dip in technology and downplaying inflation, than looking at the hard reality; the world has hit a physical limit with a galloping energy crisis and a global food crisis that is only to get worse.

Many argue that drawdowns are short and that equities will quickly come back, but this type of thinking is misguided as it is mostly driven by the drawdown structure since 2010 which has been an outlier in the greater history of capital markets. The longest drawdown since 2010 was the period 2015-05-22 to 2016-07-11 which took 286 trading sessions. The current drawdown is the 4th largest since 2010 and the average number of days to the trough of the 10% or worse drawdowns since 2010 (there are seven of those) is 76 days, so if we apply the post financial crisis years as our baseline of course investors should buy the dip and the sunset is near. Unfortunately these samples are the wrong ones to apply.

If we look at the 30 largest drawdowns since 1928 in the S&P 500 there is a striking pattern. Either a drawdown reaches its trough fast or it takes a long time. The middle ground seems to be small. The total length of a drawdown, that is the combined length of first going to trough and then a full recovery to the past peak, is a function of the drawdown depth itself but also the length to the trough. Instead of naively applying the same weight on all historic samples some should have a higher weight as they are more relevant for the current regime.

We would argue that the drawdown after the dot-com bubble has similarities to the current drawdown due to above average equity valuation we reached this time in the MSCI World. The two other drawdowns during the early 1970s and late 1970s have similarities to the current inflation shock, supply constraints, and commodity crisis that we observe today. These three drawdowns had trading sessions to trough of 360 to 637 days (1.5 to 2.5 years before reaching the bottom) and a full length of 820 to 1898 days, that is around 3 to 7.5 years. In other words, the painful reality is that we might have just started on a very long journey into the unknown and something that looks very different than our past 12 years of experience.

The VIX forward curve as we have recently described is still relatively flat and is not suggesting panic or capitulation mode in US equities, so the worst is likely to come. The best investors can do is to think about balance. What will work during these times? Blend equities with short-term bonds, inflation-linked bonds, real estate, and then within themes get exposure to commodities, logistics, defence, cyber security, semiconductors, India, and renewable energy. The only thing investors must not do is to base decisions on their experience over the past 12 years.

Source: Bloomberg
Source: Bloomberg and Saxo Group
Source: Bloomberg and Saxo Group

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank (Schweiz) AG
Beethovenstrasse 33
CH-8002
Zurich
Switzerland

Contact Saxo

Select region

Switzerland
Switzerland

All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law.

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.