Why the rebound in the stock market is no reason to cheer

GMO’s James Montier tries to make sense of the the frenzied pullback in the US stock market and to him, it doesn't make any sense


Just a few short months ago I was bullish and penning my thoughts on the fear and psychology of bear markets. Little did I know, I would find myself writing about the opposite situation in such a short space of time. However, since those dark days of late March, the US equity market has rallied some 47%, other world markets nearly 38%, and even my much beloved emerging markets have turned in a 36% increase.

Both the speed and scale of the US equity market decline and its rebound are rare events. In terms of the scale of decline and its speed, I have been able to find only a few other examples to offer as comparison to determine whether sharp declines are often followed by sharp rebounds. We saw similar declines over roughly the same time period in 1987 (obviously, October 1987), late in the Global Financial Crisis (December 2008), and early on during the Great Depression (November 1929). Of the three, only the Global Financial Crisis experienced a similar, very sharp recovery (and this ignores the fact that the market had already declined by 40% before the period of the very sharp sell-off).

It would, of course, be foolhardy in the extreme to extrapolate any conclusions from a sample size of just these events. But, I do believe I can say that a market does not have the divine right to display a sharp bounce-back after a sharp decline.

As is often the case, it now appears as though most market participants – I hesitate to use the term investors – are back in full swing with Ian Dury and The Blockheads’ Reasons To Be Cheerful echoing through their heads. I have written countless times over the years that overoptimism and overconfidence are a particularly heady and potently dangerous combination because they lead to the overestimation of return and the underestimation of risk. This combination strikes me as the best description of our current juncture.