Expecting the best, preparing for the worst

Jul 12, 2021 | Jonathan Yung


The second year of a bull market

After a strong equity market performance in the first half of 2021, we should take a step back to gauge what the history books may foresee ahead. Without any notable pullbacks, some investors have a hard time re-entering the stock market as many indexes have already eclipsed their pre-pandemic highs. In the chart below, we can see the S&P500 has fully recovered and resumed the upwards trend that was in motion before the pandemic.

With the global economies beginning to open up alongside accommodative monetary and fiscal policies, the market outlook should be bright. Using RBC Wealth Management’s recession scorecard, investors can see that the 6 leading economic indicators are still signaling an expansion mode. Longer-term stock returns tend to coincide with the business cycle and therefore we do not expect equity underperformance until the anticipation for a recession is heightened.

Even with this promising outlook, stock markets never go up in a straight line. As my colleague wrote in the blog entitled, Even Good Years Have Bad Days, investors have experienced 10%+ negative drawdowns in over half of the years since 2000.  As we enter the second year of this new bull market, we are also interested in knowing the magnitude of pullbacks historically experienced during these periods. The chart below shows that pullbacks range from -5.1% (1974) to as much as -16 % (2009).  Overall, the average bull market saw max drawdowns  (largest peak-to-trough selloff) of -10% during year two.

As of March 2021, we have only experienced a 4% pullback, which leads some investors to expect more volatility ahead. Despite potential future drawdowns we continue to focus on the constructive economic fundamentals and buoyancy of corporate earnings. Thus far, corporate guidance trends suggest Q2 earnings season will be very strong.  According to data from FactSet, “a record number of S&P 500 companies have said their second-quarter earnings would be better than what analysts expect. Of the S&P 500 companies, 103 offered Q2 earnings guidance. A record 66 of these companies provided positive guidance.” This has led some investors to believe that analysts are still too conservative about their earnings prospects. Should companies continue to grow earnings faster than expected, this will assist in lowering the Forward Price-to-Earnings ratio, which is a key valuation metric for the market. With continued earnings growth, this will act as a supportive backdrop for equity investors. That being said, given the strong stock performance seen thus far, we recommend a disciplined rebalancing of one’s portfolio.