For many, October has gone from spooky to downright frightening. However, in reality, it’s not a nightmare or a tragedy.
Why is this happening? In short, we are experiencing the second market correction in 2018. There are some who may be pounding their chests yelling “I saw this coming!” But if you look at our commentary starting mid -December 2017, I discussed the possibilities of what could happen in 2018. If you read through some of those commentaries, you will notice the risks that we face now are exactly the risks we identified.
This past week capped off a few weeks of rising tension and deepening market correction. Nobody can consistently and perfectly time market corrections. Not only do corrections occur due to a variety of reasons, they happen in a snap. This leaves investors with the challenge of riding it out or reacting too soon and then being left with determining when to get back in.
What we continue to do is look at the data. Lots and lots of data. It is often a whirlwind of sorting out emotions from real data when we are considering the current market correction. I find much of what is on CNBC to not really be all that helpful, but there was an article last week that I really thought could be useful for investors. “The average correction for the S&P 500 since World War II lasts four months and sees equities slide 13% before bottoming,” according to analysis at Goldman Sachs and CNBC.1 At this point there is little to no evidence that we are entering a recession yet. Here are the facts:
Normal market corrections tend to happen so fast that often the best course of action is to simply remain patient, assuming you have at least 4 months where you can wait it out. The bigger question always comes in when we consider the transition from market correction to a bear market.
We must look at data in order to gain perspective. This helps take out some of the emotion and let us focus on how to be prepared if a bear market develops from what originally looks like a market correction.
For perspective, I like to look at a closing price chart of the S&P 500. I look at the market high versus an established support level, which is normally developed from the last market correction. The market high in September, for the S&P 500, was 2,930.70. The major support line is 2,630. The low of 2018 was 2,581.88.
So far the market has recovered from both last Wednesday and Friday, when numbers slid close to 2,630. That is a good thing, and viewed as a support line. It is the price level that attracts buyers back into the market (normally short-term traders). What I really compare these points to is the 13% loss of an average correction (which is actually just below the 2018 lows, but only by a couple %). I also include a 20% loss point for reference and to gain perspective. From where we closed last Friday, we would see at least that much additional loss before we get to a bear market.
As we continue to examine the data we are looking for a few things. We either need to see evidence that this correction is going to go much deeper, or that we are forming a market bottom.
Evidence that this correction is going deeper is found in a continuing breakdown of underlying stock prices with a high correlation. In English, that means everything continues to move together. However, it’s not necessarily a good short-term sign.
If we continue to receive evidence that monetary policy is going to continue to become more restrictive (Fed raising rates), and the economy shows signs of slowing down, the correction could deepen even more.
On the positive front, if we see the VIX spike and volume increase, or see a strong upward surge where stock prices advance 10:1, we would have evidence of a bottoming process. That would be a good sign for the markets in that they are beginning their recovery.
Unless there is a breakdown, which is possible, we would view this correction considering the overall trend and not expect it to deepen more than a max of 20%. Now, 20% is a lot, but it can be recovered relatively quickly (think months not years). The danger of a bear market, even in the context of no recession, is that it lasts much longer than a correction. That is something we want to avoid if possible.
Emotions are not helpful in these times, no matter how spooky it gets. The benefit we have is that data is continuously available to us and we will maintain our discipline of managing portfolios based on rules that avoid emotional mistakes.
Continue to look forward to a positive future, and try not to get mired down by the frights that show up from time to time. If this correction proves to avoid becoming a “nightmare”, we can take some solace in the fact that we can begin looking for a recovery.
Most importantly, we will see the other side of this correction, just like we have every other market correction. We are not looking at a “2008-like” crumbling of our financial system. In other words, this is not “the big one.” It is simply an unpleasant, but relatively orderly, market correction.
1-The stock market loses 13% in a correction on average, if it doesn’t turn into a bear market. CNBC.com. October 26, 2018 [10/26/18}
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