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Market returns in perspective: what does history tells us?

Many investors have certain preconceived notions around equity returns, but history tells us some important insights. We try to use those insights to think about market returns for the year ahead.

10%+ returns have happened 60% of the time, while >10% declines have happened just 7% of the time.

Mid-single-digit returns happen 15% of the time (11/72 yrs). As growth slows, it is tempting to forecast mid-single digit returns, but it doesn't usually happen.

Earnings for a given year and that year's return have ZERO correlation; returns are 41% correlated to the earnings growth in the following year though. Returns are 77% correlated with changes in the multiple; part is anticipating next year's earnings growth (35% correlation to P/E changes).

Late cycle returns have been considerable; 29% average returns after curve hits zero. Since inflation has become less of an issue, the average S&P 500 return has been 15% when the ISM has gone from a peak to a mid-trough (52.5).

Leadership persists in terms of sectors and also stocks; in particular, losers tend to lose big. Accordingly, dispersion tends to rise at this phase of the cycle.

Figure 25: S&P 500 total returns by year

60%												10%+ returns have happened 60% of the time
50%
40%
30%																																														2-9% returns are
20%																																														rare
10%
0%
-10%
-20%			Brown = recession year
-30%
-40%
-50%
1954			1958	1995	1975	1997	1950	1980	2013	1985	1989	1955	1991	2003	1998	1961	2009	1967	1976	1951	1996	1963	1983	1982	2017	1999	1972	1952	1979	1986	1949	1964	1988	2012	2006	2010	1971	2014	1965	1959	2016	1968	2004	1993	1992	1956	1978	1984	2007	1948	1987	2005	1947	1970	2018	2011	2015	1994	1960	1953	1990	1981	1977	1969	1962	2000	1966	1957	2001	1973	2002	1974	2008
Source: Haver, Bloomberg, UBS
Figure 26: S&P 500 annual returns and earnings growth																																					Figure 27: S&P 500 returns and changes in the P/E

45%		Y = S&P 500 annual returns			45%
						y = 0.59x + 0.07
		X = S&P 500 EPS annual growth
							R² = 0.59
30%					30%
15%					15%
0%					0%
-15%			y = -0.02x + 0.09		-15%
			R² = 0.00						Y = S&P 500 annual returns
-30%			ZERO correlation for		-30%
			annual returns and						X = S&P 500 P/E annual % change
-45%			EPS growth		-45%
-20%	0%	20%	40%	60%	-45%		-30%	-15%	0%	15%	30%	45%	60%

Source: IBES, FactSet, Haver, Bloomberg, UBS

Source: IBES, FactSet, Haver, Bloomberg, UBS

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Late cycle returns have been sizeable

It has been over nine years since the end of the 2008-09 recession and investors are becoming more focused on what the later stages of the business cycle will entail for equity markets. In particular, as the Fed raises rates and the curve gets closer to inverting, investors are thinking about recession risks on the horizon. We use the point at which the 10-2y spread hits zero to assess "late cycle" developments, which happened in Apr-68, Mar-73, Aug-78, Dec-88, May-98 and Dec-05.

As the UST curve is still flattening, we would point out that the S&P 500 has rallied an average of 15% in the 12 months before the 10-2y hits zero. S&P 500 returns have averaged 29% from the point that the curve inverts to the subsequent equity peak, which can be as early as 5 days and as late as 27 months from the inversion. Recessions on average start 21 months after inversion, with a range of 9-34 months. From a worst case perspective, S&P 500 drawdowns have been down 2343% from the point of inversion, though the S&P 500 never fell below inversion levels through 1978-1982 and 1988-1991.

Figure 28: US Treasury curve inversions and S&P 500 performance

		US 10yr minus US short term rates (2yr, 1yr)						S&P 500 total return index (log, rhs)			10000
2.5
1.5											1000
0.5
-0.5											100
-1.5
-2.5											10
61	66	71	76	81	86	91	96	01	06	11	16

Source: Haver, UBS Note: UST 10yr minus UST 1yr from 1961 to March 1976 and UST 10yr minus UST 2yr after March 1976.

Figure 29: S&P 500 returns are high before curve inverts… Figure 30: ...and after the curve inverts

35%				12mon to inversion		33.2%
30%
25%
20%	Average return ~15%				18.2%
15%	12.3%		13.2%
10%		7.5%					6.8%
5%
0%
	68-Apr-11	73-Mar-09		78-Aug-17	88-Dec-13	98-May-25	05-Dec-26

Inversion date -- >

Source: Haver, UBS

60%				Inversion date to S&P 500 TR peak
					50.3%
50%						40.9%	41.0%
40%
30%		Average ~ 29%						27.6%
20%		14.7%
10%			1.1%
0%
		68-Apr-11		73-Mar-09	78-Aug-17	88-Dec-13	98-May-25	05-Dec-26

Inversion date -- >

Source: Haver, UBS

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ISM peak to midpoint (~52.5): ~9% type returns

We use the ISM manufacturing index as a guidepost to assess how equities behave through different phases of the economic cycle. We divide the cycle into 4 phases using the median ISM level (~52.5) as the midpoint: 1) ISM trough to mid-peak (avg 9mo), 2) mid-peak to peak (17mo), 3) peak to mid-trough (14mo), and 4) mid-trough to trough (12mo). For purposes of our analysis we assume that the ISM has peaked and we are in the phase of solid but slowing growth. We find that the cycles have been very different since 1983-84, after inflation normalized and services became a more important part of the economy.

S&P 500 returns have been 9% (median) when the ISM is high and falling.

During the period when the ISM has gone from a peak to a mid-trough, the S&P 500 has averaged 13% returns in the instances since 1983 (9% median); that compares to an average 14% decline prior to 1983 when manufacturing was more important for the economy. Average monthly returns have been over 6% annualized using months when the ISM was high but falling. Looking through the cycle, the average S&P return from the peak in the ISM to the subsequent trough in the S&P 500 has been +2% with a wide range since 1983 (-2% for all episodes), suggesting that the balance of risks at this stage is still tilted positive.

Market usually peaks when ISM <50; Aug-18 peak points to Oct-20 trough.

The average timing of ISM cycles would have pointed to a peak ISM in Feb-18 (that was it) but tax stimulus likely lengthened cycle by 6m+ (Aug peak). Tariffs have been a headwind since then. Average timing in the ISM cycle would have pointed to a mid-trough in April 2019 and a trough in April 2020. Assuming the tax cut shifted the US cycle out 6m, the mid-trough would be Oct 2019 and trough in Oct 2020. However, later cycle fiscal stimulus and tariffs are likely impacting the timing and magnitude of the cycle, making it choppier with higher two-sided risk.

We use two approaches to calculate average sector and IG performance through the different phases of the ISM cycle: 1) returns from point to point; and 2) returns conditional on the ISM level and change over a 3m period (annualized). We have data since 1955 but focus on returns since 1983. For the most part, the conclusions for sector and IG performance are the same using the point-to-point and conditional 3m return approach, but we use the average of the two methods to de-emphasize the differences. We do find the ISM high/falling phase has more disparity in sector/IG returns between the two, implying other factors are key.

Figure 31: S&P 500 performance through ISM cycles

66

62

58

54

50

46

42

38

Mid

Trough

ISM mfg. average around the cycle

S&P 500 perf since 1984 (rhs, indexed)				156
S&P 500 perf from 1955 to 1984 (rhs, indexed)				148
				140
				132
				124
				116
				108
				100
				92
Trough	Mid	ISM	Mid	Trough
	peak	Peak	trough

Source: Institute for Supply Management, Haver, UBS

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Figure 32: S&P 500 returns from the ISM peak to mid trough (52.5)

50%

40%

30%

20%

10%

0% -10% -20% -30% -40%

S&P 500 annualized performance

Inflation more of an issue,

ISM peak to mid trough

Average = 13%

more a mfg economy

Median = 9%

Inflation less of an issue,

services more important

05/59 12/61

11/68 01/73 07/78 12/83 12/87 11/94 07/97 11/99 05/04 02/11 08/14

to

to

to

to

to

to

to

to

to

to

to

to

to

02/61

11/70 01/75 05/82 05/85 01/91 01/96 12/98 10/01 12/08 11/12 01/16

ISM peak to trough dates

Source: Haver, FactSet, UBS

Figure 33: ISM manufacturing index has been a good indicator of market cycles

75				ISM mfg.			Peak		Mid trough			Trough			Mid peak			Both
70
65
60
55
50
45
40
35
30
25
55	58	61	64	67	70	73	76	79	82	85	88	91	94	97	00	03	06	09	12	15	18

Source: Institute for Supply Management, Haver, UBS

ISM is a guidepost for sector and style investing

Healthcare, Tech & Utilities have outperformed during the ISM high/falling phase, Materials the big underperformer, others mixed. We have been largely positioned for solid but slowing growth, overweight Tech and Healthcare which have typically done well at this phase of the cycle. Utilities have also outperformed on average through the ISM high/falling phase. On the other hand, Materials have underperformed an average of 10% annualized during this stage. Relative performance of other sectors such as Financials, Industrials, Consumer and Energy has been more mixed with average in line relative returns.

At the industry group level, Autos and Semis have been big underperformers at this stage of the cycle, while Pharma/Biotech, Media and Tech hardware have been notable outperformers.

We take a more detailed look at sector, industry and factor performance through the phases of the cycle in the strategy section of the piece, particularly as it relates to recent performance and the reset in valuations.

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Figure 34: Sector relative returns through the phases of the ISM cycle (total returns vs. S&P 500, annualized)

Low and rising ISM

High and rising ISM

High and falling ISM

Low and falling ISM

-20% -10% 0% 10%

-20% -10% 0% 10% 20%

-10%-5% 0% 5% 10%

-10% 0% 10% 20%

Cons Disc

Tech

Health Care

Cons Staples

Fins

Energy

Utilities

Health Care

Tech

Industrials

Tech

Telecom

Materials

Materials

Industrials

Cons Disc

Industrials

Cons Disc

Fins

Utilities

Health Care

Fins

Cons Staples

Fins

Cons Staples

Health Care

Cons Disc

Industrials

Energy

Cons Staples

Energy

Tech

Telecom

Telecom

Telecom

Energy

Utilities

Utilities

Materials

Materials

Russell 2000

R 1000 growth

S&P 400

R 1000 value

S&P 400

S&P 400

R 1000 growth

S&P 400

R 1000 growth

S&P 100

S&P 100

R 1000 growth

R 1000 value

Russell 2000

Russell 2000

S&P 100

S&P 100

R 1000 value

R 1000 value

Russell 2000

Source: Haver, FactSet, UBS

Figure 35: Industry group relative returns through the phases of the ISM cycle (total returns vs. S&P 500, annualized)

Low and rising ISM

High and rising ISM

High and falling ISM

Low and falling ISM

-15%

0%

15%

-15%

0%

15%

-15%

0%

15%

-15%

0%

15%

Semis & Equip

Tech Hdwr & Equip

Pharma Biotech & LS

Food Bev & Tob

Autos & Comp

Software & Svcs

Media

Pharma Biotech & LS

Div Financials

Real Estate

Tech Hdwr & Equip

Food & Stap Retail

Retailing

Semis & Equip

Div Financials

HH & Personal Prod

Software & Svcs

Energy

Utilities

Consumer Svcs

Consumer Svcs

Capital Goods

Real Estate

Retailing

Tech Hdwr & Equip

Media

HC Equip & Svcs

Telecom

Materials

Retailing

Consumer Svcs

HC Equip & Svcs

Banks

Autos & Comp

Food & Stap Retail

Software & Svcs

Real Estate

HH & Personal Prod

Food Bev & Tob

Utilities

Media

Materials

Capital Goods

Semis & Equip

Transportation

Div Financials

Insurance

Transportation

Cons Dur & App

Insurance

Software & Svcs

Media

Insurance

HC Equip & Svcs

Retailing

Insurance

HH & Personal Prod

Consumer Svcs

Energy

Cons Dur & App

Pharma Biotech & LS

Food Bev & Tob

Telecom

Banks

Capital Goods

Banks

Transportation

Capital Goods

Food Bev & Tob

Pharma Biotech & LS

Banks

Div Financials

Com & Prof Svcs

Transportation

Cons Dur & App

Com & Prof Svcs

HC Equip & Svcs

Telecom

Com & Prof Svcs

Energy

Energy

Com & Prof Svcs

HH & Personal Prod

Tech Hdwr & Equip

Food & Stap Retail

Cons Dur & App

Materials

Materials

Telecom

Food & Stap Retail

Semis & Equip

Real Estate

Utilities

Utilities

Autos & Comp

Autos & Comp

Source: Haver, FactSet, UBS

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