Fisher Investments UK Reviews the Bounce Effect and How Investors Can Use it

Bear markets are fundamentally driven declines exceeding -20%, which Fisher Investments UK’s reviews of market history find precede bull markets – when equities broadly ascend over a prolonged period. Studying these transitions, we have also found a recurring pattern: typically what falls furthest in a bear market bounces the highest during the subsequent bull market’s initial recovery. We call this phenomenon the Bounce Effect, which we detail here – describing why it works and how investors can use this knowledge in the future.

Whilst bear markets ordinarily see most equities fall, Fisher Investments UK’s reviews of them show some equity categories fare worse than others. However, we have seen the worst performing equities during a bear market tend to do best at the beginning of a bull market’s subsequent upturn – i.e., the bounce. For example, in 2020’s pandemic lockdown-driven bear market, the Energy sector plunged the most, falling -45.4 versus the MSCI World Index’s -26.2%.[i] But Energy did best in the following recovery, up 53.0% against the MSCI World’s 29.9% over the next few months after the trough.[ii]

According to our analysis, this general pattern repeats in other market cycles. For example, in 2007 – 2009’s global financial crisis, after Financials cratered -67.7% in the bear market versus MSCI World’s -40.1%, it led in the immediate aftermath – up 112.4% compared to the benchmark’s 47.9% six months from the low.[iii] Same with Tech after the dot-com bubble burst. During the 2000 – 2003 bear market, the Information Technology sector’s -79.1% greatly lagged the MSCI World’s -53.9%, followed by a big 48.5% eight-month bounce during the bull market recovery that topped other sectors’ and the MSCI World’s 30.9%.[iv]

Why does the Bounce Effect work? Fisher Investments UK’s reviews find sentiment towards the hardest-hit equities and categories usually overshoots to the point that any reality short of disaster can positively surprise. Those viewed as the epicentre of bear markets’ fundamental causes usually face the most pessimistic attitudes, in our experience. For example, many headlines we read during the late-2000s’ global financial crisis implied the banking system’s total collapse – which didn’t occur. Coverage we saw after Tech’s 2000 downfall suggested it would never recover, and though it took time, the sector dominates today.

In our experience, when the consensus expects the worst to occur, forward-looking markets pre-price that scenario – and move on. That also establishes conditions ripe for a new bull market to begin, in our view. The more the gap between expectations and reality is stretched, the likelier bigger the rebound – as was the case with Tech in 2003 or Financials in 2009. That doesn’t mean such categories will lead for the entire bull market, but early on at least, we think they are spring loaded for outsized rebounds.

To take advantage of the Bounce Effect, in Fisher Investments UK’s reviews of market turning points, investors can position in areas that appear to be most out of favour. Now, we find bear markets’ ends don’t announce themselves – there is never an all-clear signal. Based on our research, these periods feature deep pessimism and negative expectations far out of line with reality. Those conditions can make it difficult to have a level-headed approach to markets.

For us, identifying groups and equities fitting the Bounce Effect criteria – much less having the wherewithal to add exposure to them – takes research and preparation to enact. Keeping the phenomenon’s history in mind can also help. Now, our aim in doing so isn’t to maximise returns – we think diversification is vital, even including groups you don’t expect to lead. Our aim is to increase the likelihood of participating in a new bull market. In Fisher Investments UK’s experience, owning equities fitting the Bounce Effect can help with positioning in that regard.