In a previous article for Financial Advisor, Aaron Brown of AQR Capital Management advised buying stocks after the S&P 500 had recouped half of its losses for the year, pointing to historical context to back up that advice. Now, in another article in Financial Advisor, he writes a mea culpa, as we encounter only the second time since 1873 when that advice was a mistake.
Buying stocks at the halfway recovery point—defined as the first month end after the 15% loss when the S&P recovered half its value—and holding them until the market peaked again or hit another bottom was a winning strategy 22 out of the 24 market declines since 1871. Only one other time did investors lose money with this approach, in April 1930. In 151 years of history, what makes the April 1930 and August 2022 markets unique? Brown points to value and relying on “momentum strategy,” counting on trends to pay off. But that approach is only a winner if you’re buying stocks that are cheap, but whose price is rising. Investors who follow trends too closely can find themselves stuck in a bubble, or selling off in a panic. Getting both value and momentum can put you on more solid ground to garner returns.
According to Robert Shiller’s popular CAPE model, “the S&P 500 has averaged 17 times the average annual inflation-adjusted earnings over any trailing 10-year period,” the article details. However, since the turn of the 21st century, CAPEs have averaged higher, at 26 times. Looking at 22 instances of success in buying the halfway point, 20 of them happened when the buying occurred at CAPEs of 20 or below. Meanwhile, when the CAPE was above 20, there were two successes(2004 and 2020), one failure (1930), and one likely failure (this year).
It’s alarming to realize that when the similar scenario happened in 1930, what followed was the worst economic depression in history and World War II; it was 16 years before the CAPE came down to 11 and the markets began to prosper again. While Brown is not predicting so dire a situation as that, he writes that the downturn earlier this year “was not enough to clear out economic deadwood and deflate bubbles” and that we may still be in for some painful days to come.