Fisher Investments UK Reviews Capitulation

In Fisher Investments UK’s experience, bear markets (typically long, fundamentally driven declines of -20% or worse) often bring talk of capitulation – that is, widespread panic selling – amongst financial publications we follow. But what is it, what does it indicate and how can you spot it? Here is a primer on our views.

Capitulation describes the panic selling en masse that our research (and others we are familiar with) finds commonly occurs near or at the end of bear markets. Fisher Investments UK’s analysis finds bear markets typically start with gradual downturns when investor sentiment is cheerful, causing many to see the dip as a buying opportunity. Temporary rallies seemingly validate this but prove to be false starts, with each renewed downturn bringing more disappointment. Eventually, we have found many investors see no signs of hope remaining and pull their money from the perceived risk of equities to what they view as safe havens – think cash, bonds, or anything else that seems like it will stop the declines. In other words, they capitulate – give up hope of recovery and surrender to the downturn.

Whilst capitulation is knowable only in hindsight, Fisher Investments UK thinks a few signals typically accompany it. For one, elevated equity fund outflows may indicate investors’ fleeing equities en masse. America’s Investment Company Institute is one place to find these. Second, high investor cash balances may signal the broad shift to the supposed safe havens described above. Bank of America’s monthly fund manager survey, often featured in financial publications we follow, tracks professional investors’ cash holdings.

Investor and consumer surveys, meanwhile, can provide sentiment insights, in our view. We think widespread investor bearishness and recession expectations can indicate the deep pessimism underpinning classic capitulation. Surveys we follow include the EU Economic Sentiment Indicator (ESI), Germany’s ZEW Indicator of Economic Sentiment, and the American Association of Individual Investors (AAII) sentiment survey. Other capitulation signals, based on Fisher Investments UK’s research, can include an elevated percentage of equities at 52-week lows and relatively high numbers of equities falling below their 200-day moving averages (which reflect the average price level over the preceding 200 days). We think considering qualitative signals can be beneficial, too – e.g., what are widespread themes in popular financial publications and how do they align with broader political and economic conditions?

In our view, there have been two notable examples of capitulation in the past 15 years. The most recent was in March 2020, when the MSCI World Index entered a bear market in all major currencies amidst COVID’s global outbreak. Worldwide economic lockdowns, in Fisher Investments UK’s view, drove uncertainty and roiled economic activity, hampering equities. The index fell -33.8% in euros, with comparable declines in all major currencies.[i] European equity and bond exchange-traded funds (ETFs) registered outflows of -€11.4 billion each in March – higher figures than the 2008 global financial crisis or the throes of the eurozone debt crisis – as investors seemingly rushed for the exits.[ii] We view this as 2020’s point of capitulation – accompanied by the MSCI World Index bottoming on 23 March.[iii] Recovery began soon after, with the index surging through 2021.[iv]

The second example, in our view, was during 2007 – 2009’s global bear market. Fisher Investments UK’s analysis found a little-noticed US accounting rule destroyed bank capital unnecessarily and spurred what we think was a panicked response from the US government – which sparked uncertainty globally and drove the MSCI World Index’s long, deep bear market then – also across all major currencies.[v] As the downturn approached its end, though, many qualitative indicators we track suggested capitulation was occurring. For example, investor sentiment hit relative lows on 5 March 2009 (per AAII surveys) – a few days before the bear market’s trough (in euros) on 9 March.[vi] We also observed scores of financial headlines warning equities would continue falling with no end in sight – a sign, in our view, of the lack of hope illustrative of capitulation.

We think it makes sense to factor capitulation into market analysis when trying to determine whether a bear market bottom is close – but with the caveat that not all bear markets contain capitulation. In our opinion, it is a possible trough signal, but just one indicator to consider. We don’t think it can be used to pinpoint a trough in real-time. For example, in 1966 and 1982, America’s S&P 500 endured bear markets that both ended without many traditional signs of capitulation. In the case of 1966, Fisher Investments UK’s research found that the eight-month market downturn didn’t feature big equity outflows, liquidity issues or other telltale signs of capitulation.

In our view, investors can benefit by viewing capitulation’s presence – or lack thereof – in the context of market fundamentals, like equity supply and demand or economic developments influencing global investor sentiment. We see it as part of the potential sentiment backdrop at a market low, but Fisher Investments UK thinks hinging an outlook (and portfolio positioning) on it materializing could cause investors to miss early bull market returns.

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