The history of the markets shows it can pay to be contrarian when it comes to responding to Black Swan events. Donald Trump heading into the White House is one of the most astounding political surprises of 2016, with potentially very dark implications for markets. While it was clear he was tapping into major disaffection across the US, almost every pundit was calling a close race that would go to Hillary Clinton. Trump is an avowed isolationist – reason enough to trigger risk-averse strategies when he was seen to be leading the electoral count down to the wire. And initially, US index futures plunged more than 4% and Gold surged above $1330. But instead of the bad news momentum continuing into the European and US session on election night, the US index recovered all of its losses and closed in a very positive region with a more than 1.0% gain the following day. You may well ask, “what is going on here? Why did the market react so positively on such bad news?” I am not going to answer all the “why” questions. But I will show you that the empirical evidence of how the US index market has historically reacted to the major negative events over the past eight years, suggests it’s worth considering a contrarian approach.
Below is the monthly chart of SPX 500
Point One (August 2011) – The US was downgraded by Standard & Poor’s credit agency to AA+ for the first time in 70 years. That was a very bad news event, which drove the SPX below 1100 intra-month. But what was the consequence of the downgrade? It set a solid foundation for one of longest rallies in US stock market history.
Point Two (January 2013) – The US debt-ceiling crisis began in January 2013 and ended in October 2013, with the government shut down for more than a month. What was the result of this devastating fundamental event? The SPX rallied from 1500 to 1800, a 20% gain in 2013.
Point Three (October 2014) – The US Federal Reserve ended its quantitative easing programme, which had lasted nearly six years. No more “free money” to inject into the economy and stock market. The market dipped almost 200 points intra-month to 1800, but quickly recovered and sent the index to 2100 in the next couple months.
Point Four (August 2015) – The China Stock Market crisis started in June 2015, and by August 2015 the market had shed more 40% of its value. The crisis roiled the financial world globally and saw the SPX500 drift down to 1800 again in August. But the market quickly regained the 2100 level in the next two months.
Point Five (January 2016) – The US Federal Reserve raised the interest rate in December 2016. The Market responded to the perceived “high borrowing cost” in January 2016 and sent the SPX500 down to 1800 again. Yet again, the market surprised many by regaining the 2100 mark within months.
Point Six (June 2016) – The 2016 UK Brexit referendum on withdrawing from the European Union was a classic Black Swan event, which shook the financial world and pushed the SPX 500 below 2000 intra-month. Yet this damaging news became a catalyst for the SPX 500 to rally to all-time high.
Point Seven (October 2016) – Donald Trump wins the US president election and markets plunged. Yet markets, again, soon rallied, based in part on it being an uncontested outcome, and also on the president-elect’s relatively soothing comments during his acceptance speech.
Now, while you may argue that these are random samples, there are plenty more that suggest market history repeats itself. The numerous other examples include the news around the top of the market in 2007-2008, and in 1999 to 2000, and go all the way back to major world financial collapses such as the 1929 meltdown. Other asset classes show a similar trend of recovery from disastrous downturns, for example Gold in 2011, Crude Oil in 2008, British Petroleum after the 2011 Gulf of Mexico Oil Spill, Volkswagen after its diesel emissions scandal, and Deutsche Bank in September 2016. So go back, examine the patterns following some of the classic Black Swan events, and keep in mind that it can pay to be contrarian when facing major financial explosions.
By Hao Sun