Six trading days ago, the Dow Jones Average closed at an all-time high. Yesterday’s 3%-plus drop of 831 points in the Dow was the biggest in 8 months. With the Dow down another 546 points today, this index is now 1,736 points of its high—a 6.93% decline. (A 10% decline is considered a “correction”.)
What is unusual about the current decline are the rate increases experienced in the bond market up through yesterday. Usually, a big stock market decline would trigger a “flight to quality” and bond prices would rally. Not until today did we see some bond buying. The very recent increases in bond yields were large and rapid for a typical trading week, portending to some the trifecta fears of higher borrowing costs, a downtick in economic growth, and a rotation away from equities (for those attracted to higher-yielding bonds). Add in trade concerns, you get this week’s “risk off” trading environment.
Day-to-day market declines need not negatively impact the multi-year or multi-decade growth of investor portfolios. While there are always concerns about economic growth and policy, the global economy remains in growth mode. The U.S. is especially strong. GDP growth, employment, consumer spending, and corporate earnings are just a few of many positive indicators. The past week’s stock market action may only be the market taking inventory of costs that are on the rise, trade jitters, a tight labor market, steep increases in interest rates of recent, and the Federal Reserve clearly communicating rates could continue to rise next year given strong economic conditions. The market’s concern is that the combination of these factors may result in a slowing of the economy and/or companies’ future earnings.
Market pullbacks are never fun, but they should be expected when one invests in the capital markets. Corrections, however, can serve as a foundation for markets to advance over the long-term. Remember the market correction of earlier this year—and its subsequent recovery?
Does a major decline of the past week signal that we are headed into a bear market (a 20% decline)? Bear markets typically coincide with economic recessions. As mentioned above, indications of economic activity do not forecast a recession. Yes, there have been bear markets during economic expansions, but those historically have been relatively short in duration and not as deep as bear markets during economic recessions.
The markets could simply be signaling a healthy reset on earning expectations going forward. We may be seeing the beginning of a rotation from a stock market led predominantly by technology into other sectors. If progress (or even the perception of progress) is made resolving trade-wars, we could see a recovery in two asset classes that have experienced a challenging 2018: Developed International and Emerging Markets.
Market movements like the ones we’ve seen of late are to be monitored, not feared. We prefer long-term perspectives be our guide as to actions that need to be taken.