Whilst every equity bear market (a fundamentally driven decline exceeding -20% from a prior high) has different specific circumstances and details, we think many of them—including the current one—have some commonalities. An important one, we think, is how sentiment evolves during a bear. Magnitudes, causes and durations vary—which may make bear markets seem bewildering. But in our experience, how people react emotionally to a bear is timeless.
For bull markets—periods of overall rising equity prices—we think legendary investor Sir John Templeton described sentiment’s path best: “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.” But this only takes you through market sentiment on the way up. For the other side of Templeton’s quote, Fisher Investments’ Founder, Executive Chairman & Co-Chief Investment Officer Ken Fisher reframed Templeton’s depiction: “Bear markets are born on euphoria, grow on grinding economics, mature on recession and die on panic.” This generally shows the development of bear markets, which are typically joined shortly thereafter by a period of broad-based economic contraction (a recession).
Now, 2020’s bear market didn’t follow this blueprint early on. It is fair to say sentiment wasn’t universally euphoric at the global equity market’s February peak, in our view. The ZEW sentiment index for eurozone equities was moderately positive in February at 21.6 (above zero is optimistic), but it was nowhere close to its 79.4 record high in 2000.[i] In the US, over 41% of investors were bullish, according to the American Association of Individual Investors’ survey, just above its average since 1987.[ii] Moreover, the economy didn’t begin contracting gradually this time—production suddenly stopped as COVID-19-related responses closed businesses, which halted growth.
The bear market’s unprecedented speed compressed the sentiment cycle, in our view. The MSCI World Index’s high was on 12 February, a couple weeks before shutdowns in Europe began.[iii] Then, reality still seemed sunny to us and many observers we follow. In late January, the International Monetary Fund’s World Economic Outlook projected global growth accelerating to 3.3% in 2020.[iv] Sentiment may have been optimistic, but it appeared justified and rational to us. Absent COVID-19’s global spread and the associated interruptions to business, that optimism may have eventually become euphoric. But the surprising institutional response to shut down business around the world cut the sentiment cycle’s progression short, in our view. Growing outbreaks in South Korea, Italy and Iran brought rising alarm. Italy’s first case was announced on 20 February. But a full lockdown didn’t occur until 10 March. Business closures—for weeks, if not months—erased hope economic activity might avoid a big collapse.
A global recession looks increasingly likely from the early data rolling in. Whilst we think employment data are a lagging indicator, 17 million Americans filed for unemployment benefits in March’s last three weeks.[v] Before this, there had never been a week above 700,000 in the series’ 53-year history.[vi] The eurozone composite purchasing managers’ index (PMI), combining manufacturing and services, plunged to 29.7 in March—well below the 50 level, which indicates contraction—in its biggest ever single-month drop.[vii] For the world, March’s global composite PMI fell to 39.4, its lowest level in 11 years.[viii]
Judging by financial publications we follow regularly, few would likely be surprised by recession—as sentiment seemingly reflects the bear market maturing. Forecasters from major financial firms project huge drops in Q2 gross domestic product (GDP, a government-produced measure of economic output) for most major economies. In early April, the IMF warned GDP could fall more than during the recession that accompanied 2008’s global financial crisis. Comparisons we read in the press go further. Many headlines we encounter suggest we are on the verge of another Great Depression—modern history’s biggest economic contraction on record. Many pundits we see argue the recovery, whenever it comes, will be hamstrung by high unemployment, business failures and rising government debt. To us, the mood appears rather panicky.
It isn’t clear if current sentiment marks the bear’s end. We think it will be clear only in hindsight, but the fear and panic we see isn’t unusual. We think markets, which efficiently discount widely known information, likely reflect that panic. A reality that doesn’t meet or exceed that should positively surprise investors. That is how, as Templeton put it, “Bull markets are born on pessimism.”
Whilst the current bear market is unique in its shocking speed, sentiment’s evolution to apparent panic suggests it may progress to a conclusion swiftly. Sentiment is unpredictable—and could always go lower—but the further it stretches expectations downward from likely outcomes, the easier it is for reality to positively surprise, in our view.
[i] Source: FactSet, as of 9/4/2020. ZEW equity market sentiment index for the eurozone, August 2000 and February 2020.
[ii] Ibid. AAII Sentiment Survey Bullish Percent, weekly, 17/1/1987 – 3/4/2020.
[iii] Ibid. MSCI World Index with net dividends in CAD, 19/2/2020.
[iv] “World Economic Outlook,” IMF, 20/1/2020.
[v] Source: Federal Reserve Bank of St. Louis, as of 9/4/2020. Weekly initial jobless claims, 7/1/1967 – 4/4/2020
[vi] Ibid.
[vii] Source: IHS Markit, as of 3/4/2020. Eurozone composite PMI, March 2020.
[viii] Ibid. Global composite PMI, March 2020.
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