Last week was ugly for stocks. The good news is that the stock market rises over the long run. There is 100 years of history as evidence of that. The bad news is that in the short run there may be more pain in store before that happens. Let’s take a closer look.
The good news…
The S&P 500 index dropped -4.0% last week. Yes, this is bad.
The S&P has fallen in four of the past 5 weeks, down roughly -10.0% from its previous peak set one month ago. Yes, that is even worse.
But it might surprise you to learn that a stiff decline like this is fairly common. Here are similar instances over the past few years where the S&P fell -7.0% or more in the matter of a few weeks. These periods measure from peak-to-trough:
March 2018: -7.8%
Feb. 2018: -12.0%
Jan. 2016: -13.2%
Aug. 2015: -11.2%
Oct 2014: -10.0%
Oct. 2012: -8.3%
May 2012: -10.4%
Including this latest one, that’s 8 times in the past 6 years. So these types of price “corrections” happen more frequently than we might think. Following each of these occurrences, stocks rebounded in full within 3 months. The point is that, more often than not, the market finds its footing and eventually rallies higher, even if it takes a few months to do so.
This is no guarantee that stock prices will rally in a similar fashion again here, but recent history supports it. This is the optimistic view.
The bad news…
All 7 of the prior occurrences where stocks fell happened during a bull market. What if that run is over? What if this time is different?
That question is routinely asked when the stock market becomes choppy. Many expect that another recession is right around the corner. I have contended that another major stock market decline is most likely to occur when investors are collectively complacent, not when so many remain nervous or paranoid. I sense investors are more complacent today than one or two years ago, but complacent enough? I’m not so sure.
Going beyond the emotion and turning to what the data says, the price trends will ideally tell us whether we should believe this time is different and whether we think stock prices will continue heading south.
The first thing we want to do is analyze the long-term price trends. So we look to the monthly chart of the S&P 500. Looking back to the mid-1980s, I see similarities between today and five other years: 1987, 1998, 2000, 2007 and 2015. These are highlighted in the chart below by the vertical dashed lines colored either red or blue. Take a look:
Two things to point out from above:
(1) Of these 5 comparable points in time, twice the market rebounded within months and three times the S&P fell -35%, -50% and -58%, respectively, before rallying again.
(2) Momentum is building, but in a bad way. Meaning, there is growing momentum behind falling stock prices. We use Relative Strength (RSI) as an indicator to gauge this price momentum. It helps legitimize the price trend that we believe is forming.
As of Oct. 26th, the monthly RSI reading for the S&P 500 took a big drop from its recent highs and currently sits at 56.0. If that falls much below 50.0 history suggests that steeper losses are coming (at least based on the past 30 years of market history). Bear in mind that there are still three market days left in October. The final RSI reading at month-end is what matters most.
Looking at shorter timeframes, the weekly and daily price trends are concerning as well. The S&P 500 fell further below its 200-day moving average. Meanwhile, 65% of the stocks that comprise the S&P index are below their respective 200-day moving averages. That is the worst such percentage since Feb. 2016.
Okay, so now what?
Patience and poise.
Our process did a nice job last week. Given everything I said above, we will continue relying on our analysis to limit losses should the market fall further in the weeks ahead. Any portfolio changes are likely to be gradual, not wholesale. Most accounts have a sizable cash balance right now to help buffer against losses. We are not going to rush reinvesting those funds if it looks like the market is going to fall further. Cash is never where we prefer to be, but if it is what is best in order to protect capital, then we will.
Try not overreact to what happens in a given day, week or even month in the near future. The market is likely to remain somewhat volatile, so do not be surprised by big swings both up and down in the coming weeks. Even if the market rallies for a short time, those rallies can reverse quickly and often lead to even bigger losses.
No one wants to earn back losses quicker than I do, but we cannot, and will not, be hasty about it. Unless you plan on taking all of your money out of the market within the next few months, patience usually wins in the long run.
When market conditions do improve, there are three areas I will be looking to buy (as of now): Health Care, Utilities, Technology. I will spare the analysis on those until one-or-more of these come to fruition.
In The Market...
The S&P 500 fell -4.0% last week. Let's look under the hood:
Another week where there was pain all around. The only exception was if you were invested in Treasury bonds, but that is moot because bonds have had a poor 2018 overall.
Some of the biggest companies reported quarterly earnings last week, including Amazon, Google and Microsoft. All three share prices dropped, despite those companies posting solid-or-better earnings. This shows that when the overall market is falling, it is very tough for a particular company to buck that trend. Apple and Facebook both report this week.
This is around the time that you will see opinions come out of the woodwork about what you should and should not do with your money/investments. By now you should know how I feel about the things that are said or written. My main advice is to be careful about who you take advice from. The last thing to do is become too emotional when the market gets rocky. Give me a call if you want to discuss anything that is on your mind.
In Our Portfolios...
Have a great week!
Brian E Betz, CFP®