Pro Insights

UNDERSTANDING MARKET DYNAMICS

Patterns over Analogs

Historical analysis is primarily about finding persistent patterns, rather than relying on exact historical analogies, which rarely exist. When looking at historical ratios, fundamentals, or macroeconomic data, it is crucial not to get anchored to past worlds that no longer exist.

Noise vs. Signal

When analyzing data, often the macroeconomic factors considered highly significant in the moment turn out to be more noise than signal. At a minimum, historical data can tell investors what not to bet on

Counterintuitive Patterns (Uncertainty)

Contrary to common belief, high levels of market uncertainty do not necessarily lead to lower stock returns. Historical patterns show an opposite correlation: the higher the uncertainty, the more likely the market is to rise. This is often a result of prevailing market narratives proving false

The Role of Shocks in Recessions

Recessions are statistically rare and typically require a sizable economic shock—historically, a hit of 2.5% to 3.5% of US income—to tip the US consumer into negative consumption. These shocks often originate from major movements in oil prices or actions taken by the Federal Reserve (Fed)

Importance of Offsets

When calculating the impact of a market shock (e.g., a tax on trade, like tariffs), one must consider potential offsets or tailwinds. For example, lower oil prices can nearly negate the headwind caused by tariffs, making the overall impact less recessionary than headline risk suggests

Speed of Decline and V-Shaped Recoveries

There is a strong statistical relationship between the speed of a decline during a bear market and the odds and magnitude of the subsequent rise in the S&P 500. V-shaped recoveries are common when the market rapidly discounts bad news; extremely fast declines (like the "tariff tantrum" or COVID-19 related drops) tend to be outliers that are quickly reversed

Market Resilience (Price-Insensitive Buyers)

Consistent, predictable inflows from defined contribution and defined benefit funds (estimated at $1.5 trillion annually) create a volatility dampener. These flows constitute a price-insensitive buyer that arrives reliably every two weeks, supporting the market

VALUATION

Valuation Measures Confidence

When viewed quantitatively, valuation is primarily an expression of investor confidence. As earnings become more visible—due to positive legislative activity, rising CEO confidence, or a supportive Fed—multiples are likely to go higher with no statistical cap

Lack of Statistical Cap on Multiples

Statistically, there is not a clear pattern showing where multiples need to be capped. Therefore, being highly expensive does not necessarily correlate with lower future returns over the next one or three years

Expensive Stocks Imply Higher Mid-Cycle Earnings

When stocks become expensive, it often means that the market believes mid-cycle earnings are higher than general investor consensus suggests. This implies that, in retrospect, stocks will appear to have been cheaper than they seemed at the time

Multiple Expansion Leads Earnings

A key dynamic is that multiple expansion often precedes actual earnings growth. This is frequently observed when CEO confidence bounces from low levels; the market prices in the expectation of better corporate visibility before the earnings growth materialize

SENTIMENT

CEO Sentiment as a Leading Indicator

A rise in CEO confidence is historically significant when it starts from recessionary (bottom quartile) levels. This signal is not necessarily a contrarian indicator of a market top but rather an indicator that better earnings growth is becoming more visible to corporate leaders, which leads to multiple expansion

The Danger of Bad Behavior

The primary statistical challenge for retail investors is selling at market bottoms (doing the "opposite" of what is wise). Since stocks typically bottom on bad news, using bad news as a reason to exit the market creates the difficulty of determining when to re-enter

Euphoria Marks Tops

Bull markets usually end when euphoria is statistically visible, defined by top quartile earnings growth (around 25% to 30% annualized). Markets that are "grinding it out" with more muted earnings growth (e.g., 10% cap-weighted, flat median earnings) are often durable and far from euphoric

CALLING TOPS and BOTTOMS

Credit Spreads as a Predictor

Credit spreads (the differential between high yield and the risk-free rate) are a strong predictive tool, often viewed as the "smarter market". Extremely wide credit spreads are usually indicative of a market bottom, while extremely tight spreads can indicate investor complacency and a potential top. Statistically, tighter spreads correlate with a higher probability of stock market advancement over the next year

Valuation Spreads Indicate Fear/Opportunity

Valuation spreads measure the difference in performance and price between cheap and expensive stocks. A wide gap ("blowout in spreads") is an expression of statistical fear because investors are selling anything they perceive as risky and aggressively buying perceived safe assets. Wide spreads are favorable for contrarian investing because they suggest fear is already priced into the market

Median Earnings Growth as a Fundamental Driver

Median earnings growth (earnings growth for the typical S&P 500 company) is one of the most critical predictors. It provides a clearer perspective than cap-weighted growth (which can be distorted by a few large companies) and is a leading indicator for the health of the job market

The Risk of Being Right but Not Profitable

Investors are often obsessed with predicting the market's end because "there's always something wrong". However, an investor can be right about a negative macroeconomic or historical event (e.g., predicting two back-to-back recessions) yet still fail to make money if they reduce their equity exposure prematurely or if the market climbs a "wall of worry"

Credit Market Warnings Precede Equity Peaks

Historically, leading into major market tops (like the dot-com bubble or the Global Financial Crisis), credit problems surfaced significantly earlier. The credit market signaled insolvency issues for companies months or even years before the equity market peaked, demonstrating that the market peak is a process, not a sudden event

This first series is credited to Denise Chisholm, the very insightful Director of Quantitative Market Strategy at Fidelity Investments. Her main theses are that investor perceptions about market causations are often not supported by real data and that every seemingly similar catalyst in the market plays out differently than in the past (eg. tariffs, disease, political shocks, physical disasters).