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Well, At Least October is Almost Over

By Jon Aldrich

October

October can be a great month. Fall is in full swing, and the colors and smells of fall here in the Midwest make it a great time of year. It’s that time for the smell of burning leaves and cider donuts at the orchard. It’s the time for kids to jump in leaf piles and to dress warmly and cheer on your favorite football team. The leaves are brightly colored and if we are lucky, there are still some warm days left to enjoy. However, as I am sure you are aware of by now, October has been an ugly month for the stock market, as many October’s seem to be.

I want to give everyone a heads up now so that when you receive your October statements you are prepared, as it will be one of the lousiest months we have seen in quite some time.  As I have mentioned in many of my previous missives and in the phone calls and meetings we have been having with clients, the past couple of years have been abnormally calm and that we have been a bit overdue for some higher volatility and we have certainly seen that in October as we did earlier in the year. Don’t forget, we had a 10% correction earlier in the year, and we are at around a 10% correction from the highs currently. 2018 is shaping up to be a volatile year, at least from what we are used to of late, but not historically speaking.

The combination of fears over the escalating trade war and the Federal Reserve telegraphing they are intending on continuing to raise short-term interest rates so the economy does not overheat has some market participants fearing that a recession may be around the corner in 2019. There is also some consternation with the upcoming mid-term elections and if Democrats will gain more control. The odds of a recession may have increased a bit of late, as some of the effects of tariffs are being felt in a wide range of industries, but the economy is still on very solid footing currently and things are not really all that different than a month ago before the market correction began.  The stock market probably got a little bit ahead of itself over the summer, and the catalysts mentioned above have provided a reason for the current bout of selling.

The FAANG tech stocks (FAANG is an acronym for Facebook, Amazon, Apple, Netflix and Google) which have been printing money the last few years and whose stock prices have only gone up during this time, have finally hit an air pocket. Since these stocks comprise almost half the market capitalization of the S & P 500 (see chart below) and have been responsible for a large part of its gains the last couple of years, it is no wonder when they sneeze that the market gets a cold as well. Investors have rotated out of these very pricey technology stocks and have been moving into cheaper areas of the market, which may end up being a good thing as the market leadership may become more evenly balanced rather than just being carried by these FAANG stocks.

Market Capitalization of the Companies in the S & P 500 (July 2018)

Market Capitalization

Big selloffs like the one we are currently experiencing usually end up being modest corrections and not full-fledged bear markets. The chart below from Morgan Stanley shows the top ten 35-day corrections since 1953 (we are approximately 35 days from the market peak in September). The bars in grey show the times the market recovered within 6 months to a year later. The red is the current correction through October 26, and the green bar is the one instance in the last 65 years where the market continued into a bear market.

Big Selloffs End Up Corrections

What this tells us is that sharp pullbacks like the one we are currently experiencing are generally associated with modest corrections that resolve themselves upward over the next 6 months to a year later.  Longer term bear markets generally begin with a whimper and gentle drops that do not really get the market too anxious. In fact, the 2007 selloff that started the 2008 crash doesn’t even crack the top ten as that was only about a 5% drop over several weeks.

The information that usually causes much more severe bear markets is gleaned over time. Markets don’t become smarter overnight, and usually when they do (think Brexit and the 2015-2016 China scare for more recent examples) the recoveries are relatively swift as the fears at the time were irrational.

The other item the financial media has been trumpeting is that the S & P 500 has fallen in 21 of the past 27 trading days. Sounds like we better find a bunker to hide in. Not so fast. The chart below looks at the market returns anywhere from 1 week to 2 years later that this has occurred going all the way back to 1931. Doesn’t look so bad from that does it? Of course, there are a couple instances that the market wasn’t up after 2 years but the vast majority of the time it was higher:

S&P falls 21 out of 27 trading daysSource: Bullmarkets.co

The bottom line in all of this is that sharp sudden pullbacks are more inclined to be temporary pullbacks, and that it is the slow, grinding declines that you should be more concerned with. Also, to step back and put things into perspective, here is the S & P 500 over the last 5 years:

S&P over 5 years

Finally, remember that your asset allocation is based on what is required for the long-term success of your plan which incorporates the ups and downs of the market. If this pullback or other recent corrections has caused you undue stress and anxiety, please contact us or schedule a time to discuss what your other possibilities may be. The market may still have some more downside from here, but this sharp pullback has many of the hallmarks of past corrections that resolved themselves upward within a few months.