2011 – Back to the Future?

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On October 21, movie buffs celebrated the much anticipated “Back to the Future” day commemorating Marty McFly, Doc Brown, and Jenn Parker’s time travel in the eponymous blockbuster film comparing what was predicted about 2015 in 1985 (the year the film was made) versus reality. In the same spirit, let’s take a look at what time travel between 2011 and today would look like, as there are market similarities that may prove instructive.

Looking Back at 2011
Leading up to the summer of 2011, markets had rebounded strongly from the depths of the credit crisis. The S&P 500 more than doubled off of its lows from the credit crisis, eventually reaching a peak on July 22, 2011. All this turned, however, in the mid to late summer of 2011 as a standoff in the U.S. Congress emerged that risked a shutdown of the U.S. government and raised the possibility that the U.S. might be unable to service its debt. These concerns came to a crescendo after the market close on August 5, 2011, when Standard & Poor’s announced that it had downgraded the credit of the United States from its previously unassailable AAA rating to AA+. Markets from the middle of that summer to the start of fall experienced substantial volatility. The S&P 500 sold off almost 18% from peak to trough, the Russell 2000 was down 27%, emerging markets were off 27% in dollar terms, and high yield spreads widened by 270 bps, leading to losses of about 7.6% in high yield credit. Indeed, during this bout of volatility, many market participants pondered whether the global economy had in fact recovered from the credit crisis which peaked three years prior.

The market “nadir” for the S&P 500 occurred on October 3, 2011. From there, the market bounced back sharply with the S&P 500 ending October up 10.9%, the Russell 2000 rallying 15.1%, emerging markets up 13.2%, and high yield credit up about 4.5%.

Late Summer/Early Fall Peaks and Troughs

Relative Peak (date)​ Relative Trough (date)​ Peak to Trough (%)​ October Return (%)​
​​​2011​ ​ ​ ​ ​S&P 500​ ​7/22/2011 ​10/3/2011 ​-17.9% ​10.9%
​Russell 2000 ​​7/22/2011 ​10/3/2011 -27.4%​ ​15.1%
​MSCI EM (USD)​ ​​7/22/2011 10/4/2011​ ​-27.5% ​13.2%
​CS HY Index ​7/28/2011 ​10/6/2011 ​-7.6% ​5.4%
​​​2015 ​ ​ ​ ​S&P 500 ​7/20/2015 ​9/28/2015 ​-11.2% ​8.4%
​Russell 2000 ​7/14/2015 ​9/29/2015 ​-14.6% ​5.6%
​MSCI EM (USD) ​7/17/2015 ​9/29/2015 ​-17.1% ​7.1%
​CS HY Index ​7/16/2015 ​10/1/2015 ​-5.4% ​2.6%

 

Source: Bloomberg, Credit Suisse

Fast Forward to 2015
Leading up to the summer of 2015, markets had rebounded strongly following the volatility incurred in 2011, with the S&P 500 rallying 82.5% from 2012 to its peak on July 20, 2015. Once again, mid-to-late summer brought uncertainty into the market, which came to a head with the announcement from the Chinese government on August 17, 2015 that it would moderately relax its currency peg to the U.S. dollar, allowing the renminbi to depreciate. This action was the climax of an ongoing drama playing out in Chinese markets earlier in the summer, when Chinese equity markets sold off 23.9% following a rally of over 50% (and over 100% on the Shenzhen exchange) from the start of the year. Like the S&P 500’s downgrade of the U.S. four years prior, the action was not widely anticipated and many market participants realized that concerns about China’s growth and Chinese markets were more severe than many had thought. Markets once again from the middle of the summer to the start of fall experienced substantial volatility. The S&P 500 sold off more than 11% from peak to trough, the Russell 2000 was down 14.6%, emerging markets were off over 17% in dollar terms, and high yield credit spreads widened by 140 bps, leading to losses of 5.4% in high yield credit. Indeed, many market participants pondered whether the global economy would be able to sustain or exceed its current level of growth in the future.

The relative market “nadir” for the S&P 500 occurred on September 28, 2015, (note that on August 25, 2015, the market ended lower than on September 28, 2015) and from there the market bounced back strongly, with the S&P 500 ending October up 8.4% for the month, the Russell 2000 up 5.6%, emerging markets up 7.1%, and high yield credit up 2.6%.

In both 2011 and 2015, an unforeseen macro shock sparked selling and led market participants to ponder the future of the global economy and its implications for markets. In both cases, the market righted itself with strong recoveries in October. Over a longer horizon, we might remember that the markets followed 2011 with very robust performance over the next few years. Should we expect the same to occur over the next two years?

What’s different this time fundamentally? 
As we entered the summers of 2011 and 2015, broad equity market trends had been very robust in both cases, yet today the global economy is in a very different place.

The economy in 2015 is much stronger than it was in 2011. U.S. unemployment was at 8.8% in October of 2011, compared to 5.0% today. As of September 30, 2011, U.S. real GDP had grown only 0.2% since its prior peak reached in the fourth quarter of 2007. By 2015, U.S. GDP had grown nearly 8% since that point. In 2011, housing had yet to bottom out and would not bottom until the beginning of 2012 in many markets. Today, the housing market has had price appreciation for three consecutive years.

The salient difference between 2011 and 2015 is that in the late summer of 2011, a tremendous growth opportunity for the U.S. economy remained, while in 2015, slack in the U.S. economy is not immediately identifiable. Put another way, it is not immediately apparent whether and how much additional growth can be expected.

What’s different this time technically? 
Leading up to the summer of 2011, the U.S. was just wrapping up its second iteration of Quantitative Easing (“QE”). However, the European Central Bank was still in the very early stages of pondering QE and most of Europe was preoccupied with trying to handle the seemingly imminent departures of Greece and perhaps other periphery countries from the Euro. In Japan, the arrival of Shinzo Abe and the Abenomics platform was still one year away.

In the summer of 2015, the global ‘10,000 year flood’ has occurred in terms of global quantitative easing. In the years leading up to 2011, it was only the U.S.; today, by contrast, the rest of the globe has followed suit and little dry powder remains. In the U.S., we have experienced Operation Twist, QE3, and countless delays in the removal of QE from the markets, which themselves have served as mini stimuli to the markets. In Europe we have seen several memorable quotes from Mario Draghi (“whatever it takes”, “we don’t need unanimity”, “we will do what we must”, etc.) and the coming together of different parties to address the need for monetary action. In Japan, we have seen two arrows fired and the third one sent into flight.

In other words, over the past several years, markets have relied on cheap money which facilitated the removal of slack from the economy. What can markets lean on today?

What does this mean? 
The million dollar (actually a lot more) question is whether the volatility in August and September of this year was merely a normal correction which can be expected to occur in all markets from time to time or, rather, a harbinger of substantial volatility to come. The late summer volatility in 2011 was followed by several years of robust markets. The path going forward from here is less clear given the tremendous amount of QE that is already in the system. Is it reasonable to expect the growth which has occurred over the last few years to persist given that the economy has already approached full employment and as QE programs in the U.S. wind down? Investors will have to weigh the possibilities of both occurring as they position their portfolios going into the turn of the year.

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Andrew Ross, CFA, CQF, FRM, CAIA is an Associate Director working in Portfolio Management, focusing on portfolio construction. He is actively involved in the strategy and asset allocation for the firm’s flagship Moderate Multi-Strategy portfolios and serves as a portfolio manager on three custom account mandates.

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