"The investor who says, 'This time is different,' when in fact it's virtually a repeat of an earlier situation, has uttered among the four most costly words in the annals of investing."
Sir John Templeton, 16 Rules for Investment Success, 1993
The market has an average of three to four 5% pull backs per year. The market went 416 days without a pullback, and then it broke the longest run it has had in 20 years.
Corrections are defined as declines of 10% - 20%. There have been 36 corrections since 1980 (almost one per year), with the market falling an average of 15.6% per correction. Corrections last an average of about four months, but I think this one could take six months or longer. If it’s shorter then I’ll be pleasantly surprised. Corrections are healthy, and we really needed one. I wouldn’t be bothered if the stock market dropped 20%. You might be, and I’m here to talk you through it.
What bothers me, and probably bothers you if you’re watching, is intra-day volatility. That’s the ups and downs that happen within a day. Wild swings are frustrating. Watching last week reminded me of 2011. The market ended up basically flat. The only positive return was a little bit of dividend that threw the total return up over the 0% mark just barely. But, you’d have thought it was a repeat of 2008 by the way people were acting, and I think their reactions were very rational.
2011 started as a pretty volatile year, but June to December were terrible. Things started to get really shaky in June. Then, when the US credit rating was downgraded there was an end-of-summer plunge. There were 213 days from June 2011 to December 30, 2011. The market changed directions 5% or more 12 times, or every 18 days, during those seven months. There were multiple double-digit changes in 2011. Those shouldn't even be classified as corrections. What started as a problem with fundamentals became a technical problem. Investors were at the mercy of algorithms, trading ranges, margin calls, leverage, and high volatility as the market churned. It caused rapid intra-day trading. The market could be up or down 3% or -3% at 2 pm CST and people would be making bets about where it would end when the market closed at 3 pm CST. In that hour it could have been anywhere: up, down, or sideways. It felt like it was every day. It makes it tough to decide when to trade client accounts. It’s a big inconvenience. Other than that, I was not worried but—reasonably—clients were.
Last week reminded me of 2011. It’s as if we’ve moved into an era of either placid inclines or tumultuous corrections and nothing exists in between. This is what the recovery has felt like over the last 10 years. I want to show you what this looks like. Remember that I said 10% drops are normal in one year? And that 5% drops often happen 3-4 times per year? In 2011 there were 5% swings up and down 12 times in the last 7 months of the year. That’s a swing of 5% or more every 18 days or so. That’s what happens when fundamentals push us into a correction and technicals take over. The first chart is the entire year of 2011. The second chart is just those seven months from June to December that I mentioned. Caveat: I didn’t sit with a calculator and do any math, I have a “measure tool” for the chart. So, assuming I clicked the right spot these percentages are correct. However, if I clicked a hair down or up from the top or bottom, I may have measured a little short or long. I’m talking about differences of less than 0.20%, or less than 1/5th of one percent in a possible error. So, the facts in these charts still stand. Just don’t start doing calculations and email me because something’s a hair off. I realize that could be the case.
Technical takeovers make it very difficult to apply the rules and run them correctly. It relies on keeping an eye on the real value of the market. If technicals are causing the market to move rapidly up and down, I have to continue to apply my same formulas, but I have to be more involved in analyzing the overall environment: How’s the economy? How’s the regulatory environment? What is inflation doing? How do overall stock valuations look? Is this volatility keeping me from seeing the bigger picture?
Per the Facts, Figures and Opinions section of the Monday newsletter:
In the 50 years from February 1968 to February 2018 the S&P 500 had:
19 corrections - defined as declines of between 10% and 20%, or once every 2.6 years (including the 10.2% drop that ended last Thursday)
7 bear markets - declines of over 20%, or once every 7.1 years (last one was 2008)
Declines of 20% or more happen due to one of several different factors: recession, high commodity prices, tightening of monetary policy (interest rate cuts and bond buying by the Fed), and/or "extreme valuations." Source: Business Insider
A lot of novice and amateur investors are speculating that we could be headed for a bear market specifically due to extreme valuations. The last bear market specifically caused by extreme stock valuations happened in 1961.
I remain fairly certain that this is just a correction and not a bear market, but I won't make specific predictions because, as I've said before, no one actually knows.
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