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A comparison of equity market performance today and after the Lehman bankruptcy suggests talk of a market recovery may be premature.

Following a month when the S&P 500 Index had its best return in over three decades, many are wondering if we have safely returned to a directionally rising, risk-on market in U.S. equities. The velocity of the rally has been tremendous, dating back to late March and including the “strongest 3-day percentage increase since 1931”1. Still, even after the market upturn, most equity indices remain in negative territory for the year, down (10%-20%) year to date.
Much has been written about how the market decline, precipitated by the deadly COVID-19 pandemic, is unlike the global financial crisis of 2008. While the primary causes behind the steep equity losses in both 2008 and 2020 are very different, the immediate effect on the S&P 500 Index was actually quite similar:

Exhibit 1 highlights the daily performance of the S&P 500 Index in the fall of 2008 following the Lehman bankruptcy and the market performance since the equity peak in late February of this year. The recent rally is quite reminiscent of the period immediately after Lehman filed, when the S&P 500 rallied by nearly 20% on two separate occasions in October and November 2008.2 Back then, like today, markets soared following the aggressive policy response to combat the financial crisis. If there is one notable difference, it would be the immediacy of the fiscal and monetary response in 2020. Policymakers moved swiftly and dramatically to combat the decline in global economic activity coming into April. While those actions have helped lift equity markets over the past four to six weeks, one wonders how much of the potential recovery has already been “pulled forward” and may result in a more volatile, challenging environment in the months and years ahead.
Since the Financial Crisis of 2008, each equity sell-off was typically met by an aggressively accommodative policy response, and any investor that pursued a “buy-the-dip” strategy was handsomely rewarded. It is not difficult to see why some investors have a high degree of conviction that, at least from a market perspective, the worst might be now behind us and the “temporarily disrupted” bull market in equities is already on the mend. A longer-term historical perspective doesn’t easily support that optimistic belief, however.
Back in 2008, we saw many long-only equity managers pounding the table, enthusiastic about the buying opportunities. But, as is often the case during periods of severe market dislocations, the downward pressure on equities persisted for several months following the initial market sell-off, even with strong intra-period rallies.

Exhibit 2 extends the time period into early 2009. That market decline lasted another 4-plus months. In fact, following the earlier 10%-plus snapback rally, the Index proceeded to fall by another -30%, bringing the total drawdown to nearly -50%. Clearly, the most aggressive investors in the early days of the 2008 market sell-off suffered a “double whammy” of (a) initially losing -30%, recouping some losses, perhaps feeling emboldened or fearful of missing out, and then (b) seeing the value of their long-only equity investments depreciate by a similar order of magnitude over the subsequent months. Back then, it took a full 2+ years for markets to return to their September 2008 levels3; extending this look-back period to Oct. 2007, it took 5½ years (until April 2013) for the S&P 500 to fully recoup its losses.
So what can Advisors do to drive performance and maintain exposure to appreciating assets, without subjecting clients to significant downside risk? Back in 2008, as in the current environment, the risk-reward characteristics of other financial assets and strategies less sensitive to directional equities provided opportunities for substantial portfolio gains. Examples include actively managed funds focused on securities higher in the corporate capital structure, many of which have been sold off considerably and are likely to go through complex events to unlock future value. The current market is estimated to have over $1 trillion of securities now trading at distressed levels3. These include both investment grade and high yield bonds, leveraged loans, municipals, structured credits and opportunistic equities. In many cases, their future price is linked directly to company-specific fundamental values, pending corporate events and identifiable near-term catalysts, and these securities are far less dependent on equity indices returning to their previous highs.
Many market prognosticators and industry leaders are once again suggesting that now is the time to get back into the stock market. That certainly may prove to be a prescient call. Investors must tread carefully, however, given the uncertainty around the long-term COVID-19 effects on the global economy, combined with the risk of weaker-than-expected earnings, declining revenues, slowing growth, falling profit margins, and the potential for a substantial increase in defaults and corporate bankruptcies. Ultimately, a well-constructed and broadly diversified portfolio will provide the most significant long-term value, and the best risk-reward opportunities in the current market may not be realized in publicly traded, long-only equities.
While the market risk obviously pales in comparison to the human toll associated with this global pandemic, properly considering the past is usually a pretty smart way to prepare for the future. Case-in-point: that earlier reference to the “strongest 3-day percentage increase since 1931” should be put into its proper context. That 1931 rally occurred in the midst of a peak-to-trough equity decline of 86%, with the market taking a full 22-years to reach new highs. We can all hope that history doesn’t repeat itself.
We are clearly living in a world filled with tremendous uncertainties, and for those of us who interact with clients, the responsibility we share in providing thoughtful guidance and actionable recommendations never stops. Sound advice is most valuable whenever uncertainty peaks. From our perspective, the most attractive investments on a risk-adjusted basis today reside in a few specific areas: catalyst-driven equities, and specialized credit investing across public, structured and private market strategies, including, of course, experienced stressed and distressed investment managers. Passively managed, daily-liquid vehicles that invest in these types of assets have potential liquidity risk, while long-only public equities have the potential to elevate downside risk in client portfolios. Delivering returns with an acceptable level of risk is the primary job of any Investment Advisor, and sourcing the best risk/return opportunities is an essential component in helping clients achieve their long-term goals.
In addition to the more important things in life brought on by the current crisis – like spending more time with loved ones, reading a few classic novels, or trying to learn a new language or an instrument – binge-watching new (or old) TV shows has become a popular pastime. I admit to having recently watched back-to-back episodes of an old, personal ‘80s favorite, Hill Street Blues. As some may recall, the concluding comment from Sergeant Esterhaus after every meeting was the same, and it serves as a great bit of advice regarding our collective experience in this strange new world, and can easily be used in the context of investing in the current environment. Let’s all be careful out there.

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1) Nasdaq, "Dow Wraps Up Strongest Three Days Since 1931," March 26, 2020.
2) The S&P 500 Index was +18.5% from Oct. 28th - Nov. 4th 2018 and +19.1% from Nov. 21st - Nov. 28th 2008.
3) Generally defined as securities trading with at least a 10% yield over U.S. Treasury bonds.

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Joseph Burns

Joseph Burns

Joseph is a Managing Director, Co-Head of Research and Head of Hedge Fund Solutions at iCapital. Before joining iCapital, Joseph was Chief Operating Officer at TCS Capital Management, a global equity hedge fund where he focused on global business development and portfolio risk management. Joseph holds a BA in Political Science from Manhattanville College and an MBA from Fordham University. See Full Bio.