The volatility in the markets this past month, with the S&P 500 briefly entering correction territory (a drop of at least 10%), has brought the second correction in less than a year, with a pullback of more than 10% also having occurred in early 2018. Corrections can cause a lot of anxiety. However, it’s important to recognize that financial markets have historically seen a significant pullback at some point during most years while still delivering positive returns over the full year. In our view, one of the most important things that we do is help our clients keep their emotions in check in times of market turmoil.
So, to help keep things in perspective:
- Since 1980, in any given year, the market has dropped on average around 14%. So far, this correction has not achieved the level of that average drop.
- Historically most corrections have not become bear markets (that is, periods when the market has fallen by 20% or more). There have been 22 market corrections of 10% or more since 1974, and only four of them have turned into bear markets. From the end of the last bear market in March of 2009, there have been six corrections that have not turned into bear markets, including one earlier this year.
- Historically, the last quarter of a midterm election year and the first two quarters of the following year are the best three quarters of the presidential election cycle for the stock market. While, the market has suffered corrections during that time frame in the past, they have been relatively short and shallow, suggesting that the further downside risk of this correction may be limited.
- Bear markets most commonly occur in conjunction with economic recessions, and at present there have been few indications that a recession is on the horizon. In fact, an often-cited culprit for the recent stock weakness has been an offshoot of strong economic growth: rising interest rates. The Federal Reserve has been raising rates since late 2015 as the economy has flourished and is widely expected to do so again in December.
While markets appear to also have been rattled by several weaker-than-expected corporate earnings reports for the third quarter, it has rallied recently on a number of stronger-than-expected earnings reports. So far, over three-quarters of companies reporting have beaten their earnings estimates for the third quarter.
It is very difficult, if not impossible, to pinpoint the exact moment a market is about to turn. While we could experience another leg downward, particularly around the election, it does appear that a bottom is forming. The Options market suggests that investors are more concerned about the prospects of certain individual stocks rather than the markets as a whole. Monday’s drop in the indexes reflects this: it was attributable to the sell-off of a handful of stocks, primarily the FAANG stocks that had run-up so precipitously this year. A majority of stocks were actually up for the day.
According to Ned Davis Research, investor sentiment dropped this past week to bearish levels not seen since the Presidential election in 2016. We had gone almost two years since investor sentiment reached bearish levels, the longest such streak in the past 15 years. As we have discussed on numerous occasions, this is a contrarian indicator that is actually bullish: markets rise on a wall of worry.
While worrying excessively about whether a bear market is imminent is counterproductive, being prepared, and sticking with your investment plan, is not. That is why our primary focus is on maintaining a balanced, globally diversified, portfolio that is consistent with your tolerance for investment risk and your financial plan, and rebalancing from time to time as market conditions dictate.
It’s relatively easy to take risks when the market is rising, but market downturns sometimes can be a wake-up call for you to consider your true tolerance for investment risk. If this latest round of volatility has you on edge, it may be time to discuss whether your target allocation is appropriate while also being able to meet your financial goals.
We very much appreciate the trust that you have placed in our firm to assist you in managing your financial affairs through both calm and turbulent times. Don’t ever hesitate to reach out to us if you have any questions or concerns about your financial plan, your investment portfolio, the markets or anything relating to your financial needs.