Why Will Markets Recover From ‘Brexit’? Clues From Past Crises
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Version 0 of 1. The markets looked very shaky when Britain voted on June 23 to leave the European Union. They have firmed up nicely since then. One day, perhaps three or four months from now, they are likely to look even better, until the next crisis comes. Those statements are not based on visions of the future. I subscribe to the view that while history doesn’t repeat itself, it rhymes. And in this case, history provides some limited reassurance. Barring a severe global recession, which doesn’t seem imminent, stock market drops of this magnitude generally reverse themselves within three or four months. That’s because big, quick declines embody reflexive panic — urgent desires to cut losses before the larger meaning of a market shock has been digested. Sometimes there are quick recoveries — as we saw after the initial declines after the so-called Brexit vote — which are followed by further losses until the markets find equilibrium. Jeffrey Kleintop, chief global investment strategist at Charles Schwab, last week enumerated three episodes since 2009 that started with big drops and ended swiftly with recoveries. The first started on March 11, 2011, when an earthquake, tsunami and nuclear accident all struck Japan. As I wrote at the time, the markets were initially unable to grasp the dimensions of the crisis; on the first trading day after the quake, the Nikkei stock index fell 6 percent. Accumulated losses over two trading days came to 16 percent. Yet the Nikkei returned to where it started within four months. In the United States, on Aug. 1, 2011, when Congress could not reach a deal to raise the debt ceiling, the Standard & Poor’s 500-stock index dropped 3 percent, partly rebounded, then fell 14 percent by Oct. 3. It recovered within three months. Finally, on March 27, 2012, the European debt crisis forced Spain into budget austerity, setting off labor strikes and driving the Stoxx Europe 600 index down 3 percent in one day, and a total of 11 percent. The recovery time? Again, a mere three months. “It is important for long-term investors to note that in each of these instances, stocks rebounded to their pre-shock level in three or four months,” Mr. Kleintop said, “even when a recession took place.” That said, neither Japan nor Europe nor the United States is in wonderful economic shape right now. Japan and Europe have endured severe market and economic downturns after these market shocks. The United States economy has grown very slowly and could be threatened by the shock waves emanating from Europe. It is also worth noting that the post-2009 period is too brief to conclude much about the long-term performance of the markets. There has been a tenacious bull market in stocks in the United States since then, fueled in part by central bank policy that has engineered ultralow interest rates. The market has been running out of steam. That is why a deeper dive provides a useful perspective. First, from a market standpoint, the Brexit crisis so far hasn’t caused much damage. In the history of the S.&P. 500, for example, the decline on June 24, which came to 3.6 percent, was inconsequential when measured as a percentage of the index’s total value. Using that measure, the decline ranked as only the 180th-largest since 1928, according to data compiled by Howard Silverblatt, senior index analyst at S.&P. Dow Jones Indices. What distinguished the early phase of this crisis, statistically, is that the markets were so poorly positioned in advance of the British vote. It was almost as though they were moving full speed in one direction and had to turn around and sprint the other way. Paul T. Hickey, co-founder of the Bespoke Investment Group, brought this to my attention. Using a technical indicator — the 50-day moving average of the S.&P. 500 — he found that stocks were “overbought” before the vote, meaning that traders had pushed prices well above recent levels. That would probably have been fine if a majority of voters had called for Britain to stay in the European Union. But that upward momentum before the Brexit vote set up a nasty market downturn. The combination of an overbought market immediately before an extremely oversold one was so unusual, he said, that “extraordinary may be an understatement. Using that overbought-oversold measure, the two-day price reversal was the biggest since 1928.” Only two episodes came close. One was in October 1989, when the failure of a leveraged buyout of United Airlines devastated the junk bond market. The S.&P. 500 fell 6.5 percent over two days. (That compares with a 5.3 percent decline in the two days after the Brexit vote.) There was a partial recovery and another downturn, but in less than three months the market returned to its old level. That example is comforting; the second is not: It occurred during World War II, when Germany invaded Belgium and the Netherlands and began to overrun France. On May 10, 1940, Neville Chamberlain resigned as prime minister of Britain, and Winston Churchill replaced him. Worldwide markets were grossly unprepared for what came next. Over two days, the S.&P. 500 in the United States declined 8.3 percent. And over the next two years, the war deepened, millions died and as an incidental casualty, the stock market declined another 33 percent. It took more than three years for the S.&P. 500 to return to its former level. In early 1940, historical stock data would not have helped much in forecasting market returns for the rest of the year. Much bigger factors than 50-day moving averages determined the course of events. If only by comparison, today’s problems seem manageable and easily understood. Events in Europe are still unfolding. But the preponderance of data strongly suggests that the markets will settle down in days, weeks or months, not years. Other crises are sure to follow in this election year. We don’t know what lurks beneath the surface of moving events and won’t find out until the smoke clears. History provides only clues, not a road map to the future. |