The S&P500 is on track to decline to 1,100, as we wrote in Jan-15 and reiterated in Jan-16. The market peaked in May 2016, and history implies it ends 50% below that peak.
The trigger for the market to fall was hard to predict. We suspected it would be EM debt, China, the Eurozone breaking up, events in the US, or a black swan. More important than the trigger, we said history showed we were near the end of the business cycle and asset prices would fall from elevated levels. Those elevated levels were a response to post-crisis easing which had given us a 5-6 year rally. The fall would feed itself in a spiral of negativity. The most interesting aspect would be if the markets began to lose faith that QE would solve the market’s problems. That loss of faith may be required for the final plunge in the bear market.
What happens next ? Of the five crashes we examine, 1929 is least relevant. Ever since then, policy makers have learnt to react differently to market falls and they have never been so steep. The 1937 double dip of the 1929 crash was already far deeper by now than we are today.
We are more like June 2008 (if we compare to the 2007 crash), October 1973, or May 2001 (the tech bubble). An average of those three crashes at this point suggests the market loses no more than 1% of its peak value (21 points on the S&P500) in any week for the next three months. In three months, the gentle slide implied by history would have the S&P at 1,677. There is obviously deep downside risk – if we were following the 1937 time-line, the S&P500 would already be at 1,250.
This feels right. Mid-2008 was three months before Lehman’s but the global economy was so strong that oil was approaching its peak of $147/bb. The ECB was about to raise interest rates as it feared inflation. Yes, Bear Sterns had raised some concerns, and the S&P500 was nearly 20% down from its peak but life for most was pretty rosy. Today the Fed still thinks it can raise rates this year.
It gets tougher later. The same methodology put the S&P at 1,515 six months from now, and at 1,295 twelve months from now. For this to unfold, we probably have to see a US mild recession in 2017. Next year is on course to be the buy of the decade.
Importantly – the initial crash of 1929 and 1973-74 and 2007-08 is worse than the double dip of 1937 or 1980-82 or 2016 – because 1) it truly is a huge shock for the markets and the public, 2) the authorities have no institutional experience of managing such a shock. By contrast, the double dip hurts badly, but everyone involved knows that economies and markets do survive a 50% fall and will bounce-back.
Why might this be wrong ? Any other bank (Albert Edwards aside), has a long list of reasons why. From my perspective, the biggest concern is that 1929/1937 and 1973/1980 were already matched by 2001/2007 – the double dip has already been and gone. 2001 was a 50% fall but Greenspan reacted quickly, and the real pain came with the double dip in 2007. If that’s right, then today is just a much needed correction with limited downside risk.
What interests me more than the S&P declining, is whether there is any chance that emerging markets can outperform. The South African rand was weaker last month than at any time in 20 years (once we stripped out inflation). We did point out in the email to clients below that $16bn of pension fund money may be coming back to cover the current account deficit. The ZAR has rallied nicely since then. If we look back at the tech bubble crash, Russia’s RTS index rose in each year from its 1999 lows. The oil price rose even as the US went into recession. This could help a number of EM markets. EM has now been in a bear market for a good few years, and is cheap relative to DM. We’re still in debate about EM outperforming. Our equity strategist Dan Salter tells me not to be silly; If US markets are plunging, EM and Frontier won’t. But if the S&P slips by 0-1% a week for the next three months, then EM might do relatively well, especially if the US dollar is weakening.
CONCLUSION: The same history chart that warned us global markets would be hurting this year – and which tell us the S&P500 will bottom at 1,100 – actually suggest the next three months will be calmer. We’re more interesting in the scope for EM to outperform DM.
Charlie Robertson, Global Chief Economist,Renaissance Capital
Twitter @Rencapman
