'How low can stocks go," The Wall Street Journal wondered on March 9, 2009, as the financial crisis was wiping away trillions of dollars from U.S. equities, the deepest rout since the Great Depression.
That day, of course, marked the bottom. The bull market that celebrated its seventh anniversary Wednesday has restored $14-trillion (U.S.) to stock values, pushing up the Standard & Poor's 500 index by almost 200 per cent.
Now, investors are awash in angst, showing little faith the run can continue. They worry about contracting corporate earnings, slowing Chinese growth and uncertainty over interest rates. And they're walking the talk by pulling cash from stocks at almost the fastest rate on record. It's not unwarranted – the S&P 500 has gained just 0.5 per cent in the past 18 months.
Yet if history is any guide, that very cynicism provides a compelling case for the run to persist, at least by traditional market analysis. Bull markets usually die amid excessive optimism, and that's nowhere to be found.
"This pervasive pessimism, skepticism and unwillingness to invest in equities anywhere near the degree we've seen in past bull markets has been a very unique characteristic," Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., said in an interview. That contrarian sentiment constitutes "the wall of worry that stocks like to climb," she said.
Consider all that money flowing out of equities. Investors took out almost $140-billion from U.S. equity mutual and exchange-traded funds in the past 12 months, more than double the peak outflows experienced over any comparable periods during the global financial crisis.
Yet when people withdraw money, stocks inversely tend to rise later, according to data since 1984. In the 12 instances when funds experienced monthly outflows that were at least two standard deviations from the historical mean, the S&P 500 rose an average 7.1 per cent six months later, compared with a normal return of 3.9 per cent, data compiled by Bloomberg and Investment Company Institute show.
Even the horrendous start to 2016 showed how skittishness may eventually work in favour of bulls. The first six weeks delivered the worst-ever beginning of a year for U.S. equities. They also saw a surge in the number of days with moves of 2 per cent in either direction.
But once things start to turn around, bears will be forced to buy. From Feb. 11 through Monday, a Goldman Sachs Group index of the most-shorted companies outperformed the S&P 500 by almost 16 percentage points, the most in data going back to 2008.
Distrust also creates bargains and emboldens future buyers.
That's the case with financial shares, which led the latest rebound from the February low. Banks and insurers, the biggest profit generator in the S&P 500 with $228-billion in income last year, still get little respect from investors after being blamed for the market turmoil during the downturn. At 13.6 times earnings, the group was handed the lowest valuations among 10 industries and traded at a 24-per-cent discount to the S&P 500.
As the market started to recover, financial companies rallied. So did some of the most-hated stocks such as energy and materials producers that had been borrowed and sold in the practice known as a short sale. The forced buying from bears therefore added additional fuel to the S&P 500's gain from a 22-month low.
What happens next? Wall Street strategists see the bull market lasting at least through December, with the S&P 500 rising to 2,158, according to the average of 21 estimates compiled by Bloomberg. If the run lasts until the end of April, this bull will become the second-oldest on record. Coincidentally or not, the past two ended near the eighth year of an election cycle.
Tom Mangan, senior vice-president of James Investment Research in Xenia, Ohio, which oversees about $6.5-billion, isn't ready to throw in the towel.
"There are too many bears versus bulls and there is too much cash on the sidelines," he said. "That means the market can do better."