Fisher Investments UK thinks a critical component of successful long-term equity investing is participating in bull markets—prolonged periods of generally rising equity markets. This may sound obvious, but it can be challenging to see when a bull market is underway. Whilst seemingly counterintuitive, our research indicates bull markets usually start when economic data are awful. Based on our study of history, the prevalence of dreary news and widespread pessimism we see today is common in early bull markets—one reason we are optimistic about where equity markets are headed from here.
What drives equities fundamentally? We think they look ahead to the next 3–30 months, focused mostly on the economic and political conditions that may impact corporate profits. Share prices, in our view, move mostly on the gap between reality and expectations—with investor sentiment influencing the latter. Generally, in our view, bull markets are born in pessimism: Scarred by the prior downturn’s declines, most investors’ expectations are extremely low. The economy also tends to be struggling at such times. Incoming economic data, like employment indicators and gross domestic product (GDP, a government-produced estimate of national output), are typically weak, which can further weigh on sentiment.
However, because equities are forward-looking, share prices already reflect the recent past and present economic conditions, in our view. According to our analysis, the rampant pessimism prevalent at the end of bear markets eventually overshoots reality. To us, this is when equities can reach their bear market low and a new bull market may emerge. Notably, this doesn’t necessarily correspond with an improving economic environment. Rather, in new bull markets, results that are just a little better than feared can drive relief, sending markets higher. Then, the more reality can exceed expectations, the more equities can climb, in our view.
We think this is why there often appears to be a disconnect between equities and economic data early in a bull market. For example, earnings are typically terrible as new bull markets begin due to the recessions—widespread declines in output across the economy, usually lasting longer than several months—that are normally associated with bear markets. But at bear market troughs, in our view, equities have digested the full extent of the earnings cycle’s downturn—and then some. When this occurs, we think forward-looking markets start anticipating a brighter future—which includes an earnings’ upturn.
Consider the 2007–2009 financial crisis. As Exhibit 1 shows, the MSCI World Index started rising in March 2009, months before the recession ended.[i] Earnings didn’t register year-over-year growth until Q4 2009.[ii] Even in 2020’s very swift downturn tied to COVID lockdowns, equities began rising in a new bull market on 16 March. Earnings data hadn’t even had time to reflect the sharp economic contraction we experienced this spring. But, in our view, equity investors generally knew those results would be awful, factored them into share prices and looked forward—past the specific results themselves.
Exhibit 1: The Earnings Cycle
Source: FactSet, as of 01/09/2020. MSCI World Index with net dividends in euros, January 2009–August 2020, MSCI World earnings per share, Q1 2009–Q2 2020.
Often, unemployment is also elevated—or even rising—as bull markets start. Many argue high unemployment levels hinder shares’ advance, for a variety of reasons, according to our regular review of financial publications. Some commentators we follow think businesses shedding jobs en masse prevents sustainable recovery. Others we read imply if the economy isn’t adding jobs, households won’t spend—also hurting economic growth.
But history suggests high and/or rising unemployment rates don’t hinder new bull markets. (See Exhibit 2.) The reason why, in our view: Labour data are particularly backward looking. Our research indicates businesses typically let go of workers as a last resort—and hire reluctantly following a downturn—due to the high fixed costs that often come with adding and training employees. Economic growth tends to lead jobs, not the other way around, according to our analysis. By contrast, we think markets are the ultimate leading indicator for growth.
Exhibit 2: High Unemployment Hasn’t Prevented Bull Markets Historically
Source: Eurostat and US Bureau of Labor Statistics, as of 10/09/2020. EU unemployment rate, January 2000–July 2020; UK unemployment rate, January 2000–May 2020; US unemployment rate, January 2000–August 2020. MSCI World bear markets, March 2000–October 2002, October 2007–March 2009 and February 2020–March 2020.
Extremely low sentiment is also common at the beginning of new bull markets. Sentiment gauges typically reflect how people are feeling in the moment, in our view. During tough economic times, people generally won’t be feeling upbeat. Rampant pessimism may influence feelings about near-term prospects, perhaps unduly dimming perceptions of likely growth ahead. The Sentix Economic Index, which surveys investors globally about their confidence on the economic outlook, illustrates how pessimistic sentiment can get at the beginning of bull markets. (See Exhibit 3.) An above-zero reading implies optimism, whereas below zero indicates pessimism. During the 2007–2009 bear market, the Index showed respondents became increasingly pessimistic—and near its lowest levels, the bear market ended. We don’t think this is a coincidence. In our view, negative sentiment lowered expectations to the point that reality could exceed them relatively easily. The Index’s readings earlier this year—particularly with April hitting lows last seen in 2009—seem to be echoing what happened at the end of the 2007–2009 bear market, in our view.[iii]
Exhibit 3: Bull Markets Are Often Born in Pessimism
Source: FactSet, as of 01/09/2020. Sentix Economic Index Global Aggregate, January 2004–August 2020. MSCI World bear markets, October 2007–March 2009 and February 2020–March 2020.
Today, whilst markets have risen well above their trough levels, commentators we read regularly doubt equities’ recovery. Yet such scepticism and other early signs point to similar conditions when prior bull markets began, suggesting to us this one is just getting started.
Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
[i] Source: FactSet, National Bureau of Economic Research and Centre for Economic Policy Research, as of 14/09/2020. Statement based on MSCI World Index, 03/09/2009, and business cycle dating committees, June 2009.
[ii] Source: FactSet, as of 01/09/2020. MSCI World earnings per share, Q4 2009.
[iii] Ibid. Sentix Economic Index Global Aggregate, April 2020.
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