It won’t have escaped investor attention that the S&P 500 has been falling since the start of the year. By 13 June it was in bear-market territory, having fallen more than 20% from its peak of 4,797 on 3 January . This has naturally focused attention on capitulation.
What is capitulation?
Capitulation means surrender, so in stock-market terms it is used to describe the point when investors throw in the towel and sell their investments. Capitulation also refers to the point when markets hit rock bottom. Essentially, this marks an opportunity for investors who benefit as markets rebound but, of course, accurately calling the bottom of the market is far from easy.
How can you spot the point of capitulation?
Unfortunately, there is no widely accepted measure of capitulation. Instead, we can use a range of different indicators to build a picture. These can include technical measures such as momentum, market volume and volatility as well as sentiment and economic indicators. For many of these indicators, there is not a single, definitive point, but a range where capitulation occurred historically, which makes it difficult to draw conclusions.
Nevertheless, it is important to understand the data because it can help provide some indication of how far through this particular market downturn we are and how much further there is to go before things improve.
Bear markets don’t follow a similar pattern. Instead, they vary enormously in length and severity. The Great Depression was the worst moment to be an investor ─ the US equity market fell 86% and took 25 years to recover . Thankfully this was an outlier and more recent bear markets have tended to be less severe with much faster recovery times. Since World War 2, bear markets have, on average, taken about 13 months to reach the bottom and two years to recover their losses .
What does our research into capitulation reveal?
Looking back over the last 30 years, we focused our research on market drawdowns of 10% (commonly called a ‘correction’) or more. We identified more than 13 of these and, for each, we looked at readings for various measures as markets turned. Our chart below highlights the corrections.
Sentiment indicators are important. Among them, the American Association of Individual Investors conducts a weekly survey of US individual investors that compares the number of bulls (investors who think the market will go up) versus the number of bears (those who think it will fall). At capitulation points, as you might expect, sentiment is poor i.e. there are more bears than bulls. In September, this indicator highlighted that ‘bear’ sentiment was higher than at any point since the global financial crisis , although it has moved slightly higher since.
Technical indicators of market ‘breadth’
By looking at the percentage of equities on the New York Stock Exchange that are trading above their 200-day moving average, we get an approximate indication of the proportion of share prices that are rising. Our research shows that this measure of market breadth tends to be low at capitulation points. It is low now.
Economic indicators are not as clear
Economic indicators like interest rate term spreads (the difference in yield between a short-dated and long-dated government bond) tend not to give as clear a guide as technical or sentiment indicators, particularly lately. Some of those measures have been impacted by extraordinary monetary and fiscal policy as well as the pandemic. Nevertheless, the Institute for Supply Management Manufacturing survey is often a helpful contrarian indicator. It shows that markets tend to rebound when purchasing managers are pessimistic. Today, the ISM manufacturing survey has fallen from its stimulus-driven high but remains (just) in expansionary territory.
Valuations have mixed results as capitulation indicators
Valuations tend to be expensive relative to history when markets fall (for example, in the dot-com bubble of 2000) and much cheaper when markets start to rise. However, the range of valuations at which market low points have occurred historically has been wide and therefore we have low conviction in what they can tell us. However, Price to Earnings ratios for the US stock market are currently relatively inexpensive compared to recent history.
What conclusions can we draw?
There are several. Markets tend to bottom out on oversold indicators when they are below their long-term averages. Capitulation points also tend to happen when trading volumes and volatility indicators are above average.
Sentiment indicators also provide some worthwhile clues while economic indicators are less useful, as shown by the wide ranges. However, the relationship between the 10-year and two-year US government bond yields are important, but today’s unusual circumstances lead us to suggest this won’t be as good a guide this time round.
Many of the indicators that we believe are quite useful in spotting turning points are now within ranges where capitulation has occurred in past. However, while markets have recently rallied from their lows, it is too soon to say that the moment of capitulation is already behind us.
While it remains difficult to predict the exact point of capitulation, carrying out such analysis helps our investment professionals at Evelyn Partners to identify and capitalise on opportunities as they arise.
 Global Financial Data/Evelyn Partners Investment Management LLP
 Doyal A., Fear as a contrarian indicator, Livewiremarkets.com, 27 June 2022
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
The value of an investment may go down as well as up and you may get back less than you originally invested.
Past performance is not a guide to future performance.