Stock market corrections take time
All investors want them and claim that they are an unpredictable, but necessary evil, an essential part of investing. However, when they come, corrections are never welcome. Some investors run for the hills as corrections are downright frightening as both the depth of the pullback as well as the length of time it will take is not known.
Corrections can be likened to a road trip to an unknown destination. How far is it? How long will it take? Should I stop (sell), take a rest and regroup? Will I ever get to where I want to go? You’re tired. You don’t know how long it will last. You are low on gas. You get our drift….
Hopefully what follows will provide some clarity to an otherwise murky topic – corrections in the stock market. The generally accepted definition of a correction is one in which the broad market indices drop at least ten percent but less than twenty percent. A decline of more than twenty percent is defined as a bear market. How often do corrections occur? The postWorld War II data suggests that corrections occur about once every year or so with an average decline of approximately thirteen percent, lasting over about four months. What is unusual about this year is that after such a lack of volatility during 2017, a year in which there were no corrections, 2018 has delivered us two thus far further heightening investor concern.
Let us first state that fundamentally, the economy is just fine. Growth as represented by Gross Domestic Product (GDP) is running at an annualized rate of approximately three percent. Unemployment is low and consumers are optimistic. Furthermore, stocks are reasonably valued, trading at a little over fifteen times next year’s earnings. So then, what is the worry?
We can identify at least three issues that have caused the recent indigestion. Number one, investors are concerned that this “Goldilocks Economy” as described above is as good as it gets. That it is all downhill from here and that all of the good news is already priced into the stock market. Although we do believe that earnings growth has peaked during this economic cycle, in part due to the boost from the tax cut, we do not believe that they will decelerate to such an extent as to warrant a long-lasting pullback in the stock market.
Number two, new Fed Chairs historically come endured a baptism of fire. For Alan Greenspan, who was appointed in August 1987, it was Black Monday which occurred on October 19, 1987, a day in which the stock market cratered more than twenty percent. For Ben Bernanke, who was appointed in February 2006 it was the Great Recession. New Fed Chair Jerome Powell, who was just appointed this past February, faces the challenge of normalizing interest rates without pushing the economy into a premature recession. In our opinion he did himself no service when on October 2nd, responding to a question from a reporter as whether the economic conditions were “too good to be true,” Chair Powell responded that it was a “reasonable question.” This suggests that perhaps the Fed would not be as data dependent as hoped and would raise rates too far, choking off the recovery.
The final reason that we believe the market has pulled back is due to the trade tiff/war with China. We liken this to a barroom brawl – after the first punch is thrown, all bets are off. Nobody can accurately predict the outcome. Investors fear that even if the United States prevails in this struggle with China, there will be economic casualties. The stock market could be one of these casualties.
Our current baseline belief is that the economy is indeed doing well and that the other two reasons for the decline, perhaps an over-hawkish Fed and a long trade war with China will both most likely be averted.
As we have stated several times within this column over the last couple of months, picking a bottom to a correction is a fool’s game. Some advice we are passing along includes the facts that bottoms to corrections are usually a process and not an event. Move up in quality. Raise a little cash so you can sleep at night. Don’t try to get all of your losses back at once. Think long-term as the stock market has always recovered from corrections as well as bear markets. Other than your job, it is your most direct route to the creation and preservation of wealth. Finally, continue to expect more volatility as regardless of the outcome with the economy, with the Fed and with China, risk has increased as we are not early in the economic cycle.
Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call 518-279-1044.