By Bryan Rich
February 5, 7:00 pm EST
We talked last week about the correction underway in stocks. As I said, since 1946, the S&P 500 has had a 10% decline about once a year. And we haven’t had one in a while. Since the November 2016 election, the worst decline in stocks from peak to trough had been only 3.4%.
So we were due. And we’ve gotten it.
Today we’ve seen it accelerate. With the steep slide in stocks today, for a brief moment, the Dow futures were down 11% from the peak of just 7 days ago.
Now, let’s add a little perspective on this …
First, as I’ve said, when you are a hedge fund or trader and you’re leveraged 10, 20, 50, 100 times, then avoiding corrections or trend changes is critical to your survival. Getting it wrong, can mean your portfolio blows up and maybe goes to zero. That’s the mentality the media is speaking to, and frankly much of Wall Street is speaking to, when addressing any market decline.
The bottom line is that 99.9% of investors aren’t leveraged and should have no concern about U.S. stock market declines, other than saying to themselves: “What a gift! Do I have cash I can put to work at these cheaper prices? And, where should I put that cash to work?” As the great Warren Buffett has said, “be greedy when others are fearful.”
So, for the average investor, dips are an opportunity to buy stocks at a discount. Don’t let the noise distract you.
Remember, we’ve talked about the transition that is underway, with a global economy that now has the potential to officially exit the economic slog of the past decade, driven by pro-growth policies in the U.S. And those economic tailwinds have introduced the likelihood that the world will finally be able to exit central bank life support (i.e. QE). That’s all very positive.
But it has also been the trigger of the correction in stocks–this transition. QE has promoted higher stock prices. Now we get a correction, and a new catalyst (earnings and the growth picture) to justify the next leg of the global economic recovery (and stock bull market).
With that in mind, the fundamentals for stocks are very strong. As stocks tick down, the better valuation on stocks will only be amplified, when we get hot first quarter earnings hitting in a few months (thanks to the big corporate tax cut). For the S&P 500 P/E: We have the “P” going down, and the “E” going up.
How long could this correction last?
Remember when we were discussing the probability of a correction back in November, we looked at this chart …
In September 2014, with no significant one event or catalyst prompting it, the S&P 500 went on a slide. Stocks closed on a record high on Friday, September 19 (2014). On Monday, stocks gapped lower and over the next 18 days fell 10%. But over the following 12 days it all came back–a sharp V-shaped recovery. It was a textbook technical correction–right at 10%, right into the prevailing trend. You can see it in the chart above: the v-shaped move in stocks, and the bounce right off of the big trendline.
What’s happened in the markets the last few days reminds me of that correction. The moves can be fast, and the recovery can be fast, in this (post-crisis) environment. Big institutions have been trading stocks through computer programs for a long time, but the speed at which these algorithms can access markets and information have changed dramatically over the past decade–so has the massive amount of assets deployed through high frequency trading programs. They can remove liquidity very quickly. Combine that with the reduced liquidity in markets that has resulted from the global financial crisis (i.e. the shrinkage of the marketing making community and of hedge fund speculators, and the banning of bank prop trading) and you get markets that can go down very fast. And you get markets that can go up very fast too.
The proliferation of ETFs exacerbates this dynamic. ETFs give average investors access to immediate execution, which turns investors into reactive traders. Selling begets selling. And buying begets buying.
With the above dynamic, we’ve seen a fair share of quick declines and quick recoveries in the post-financial crisis era.
How do things look now?
In the chart above, this big trend line represents the move off of the oil crash lows of 2016. This 2560 area would give us a 10.8% correction in the S&P 500. I wouldn’t be surprised if we got there over a few days, and a recovery began. And I expect to stocks to end the year up double digits (still).
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