With the worst performance in stocks for a Thanksgiving week since 1939, the S&P 500 has experienced a “correction.” Last Friday’s close is down 10% from its high of 2940 this past September earlier.
The S&P 500 is flat for the year, the foreign stock markets are down 10% or so, and the US bond market is down about 2%. Yet the US economy is on track to grow around 3%–higher growth rate than we’ve seen in years.
Many investors are asking, “Are we headed for a Bear market?” (A “bear market” occurs when an index declines 20% or more off its highs.) The pain of the last bear market—a decline of 57% which began in 2007 and ended early 2009—is still fresh in many of our minds.
This commentary intends to answer some questions you might be asking: What is causing the current market to correct? What might cause the bear to come out of hibernation? And what should investors be doing today?
The financial markets are forward-looking as to projected corporate earnings, the economy, interest rates, etc., yet react day-to-day to events that either confirm consensus expectations or require repricing. In our opinion, financial markets of recent are revaluing the lofty earnings expectations of companies for 2019, particularly technology stocks. Labor costs are increasing due to a tight labor market. Many commodity prices have increased. Interest rates are rising. Tariffs, or the threat of additional tariffs, are disrupting the supply chain, not only impacting the cost of components, but in some cases causing shortages. Global economies are slowing and might adversely impact sales.
Why were earnings expectations so high? For the past several years, company earnings in general have been nothing short of fantastic. Many companies benefited from increased geographical diversification of earnings and massive gains in productivity from technology innovations. Since the depth of the 2008-2009 recession, companies have built very healthy balance sheets. Accommodative monetary policies from central banks made borrowed money cheap and helped all global economies recover. For several years analysts have expected these trends to continue and have built these expectations into their future earnings projections. The landscape has now changed, and expectations are being revised down. Sometimes consensus overshoots—as it apparently has for 2019. Other times consensus undershoots. Will that happen now—and cause a further decline in the stock market?
The bogeyman to financial markets is a recession. Generally, all recessions are accompanied by a bear market. (But not all bear markets occur when there is recession!) Most recessions are preceded by a slowing economy whose momentum can cause growth to turn negative. Some “leading indicators” suggest that a recession might happen as early as 2020, but economic growth remains solid for 2019 albeit at a slower pace. A slower pace can be preferable to an overheated economy that otherwise brings inflation and aggressive monetary tightening by the Federal Reserve a.k.a. increased interest rates.
Recessions are extremely difficult to forecast, particularly if caused by some unforeseen crisis, a geopolitical event, a bursting of an “asset class bubble” (think housing), or a spike in interest rates over a short time period.
We at NWCM are not currently forecasting a recession in the very near-term. Nor do we think current market action is indicating we are heading into a bear market.Yes, we are now experiencing a “correction,” one which may only be a rotation in industry sectors, for example, from technology to consumer cyclicals and financial stocks. Such a change in market leadership can be bullish for stocks.
What should investors do given the current volatility of the financial markets?First, remember your cash flow needs and investment time horizons dictate the allocation between equity and fixed income securities.
For long-term objectives—those with time horizons of 10 years or longer—stay invested in your equity allocation and rebalance your portfolio. By rebalancing, purchases are made into investments that have recently declined in value. Additionally, rebalancing ensures a portfolio’s risk targets are maintained. When the market’s momentum reverses, a fully-invested portfolio benefits.
For investors with investment objectives of 10 years or less, review your portfolio’s allocation to bonds and cash. Do you have enough cash and bonds to ensure the income and liquidity you need for the next several years? Evaluate your portfolio’s credit quality and interest rate sensitivity.
For portfolios in which NWCM exercises discretion, we are reviewing equity allocations between U.S. stocks and foreign stocks, between value and growth, of market capitalizations and across developed and emerging markets. We’re evaluating credit quality and bond duration. We’re also looking at the mix of passive to active funds.
We leave you with a quick quiz: Question #1:Since the bear market of ’07 into ’09, how many corrections have there been in the S&P 500?
The answer is 5. They occurred in 2010, 2011, 2016, earlier in 2018 and now. Declines ranged from minus 10.16% to minus 19.39%. From market top to trough, the shortest correction happened in two weeks; the longest took 9 months.
Question #2:How long did it take for each correction to recover?
From 4-6 months.
History tells us to remain invested during corrections (and bear markets for that matter!) Have you regretted owning stocks these past 9+ years since the end of the last bear market?
Market corrections can be scary. Appropriate allocation between equities and fixed income should give you some comfort.
Please call us to discuss your concerns, if any.