The Correction of 2018, Act II

2018.03.23

We are now almost 8 weeks into the stock market correction that began on January 30. (A “correction” is defined as a decline of between 10% and 20% from a previous high; a “bear market” is defined as a decline of more than 20%.) As we said in our March 1 newsletter, “nearly every stock market correction in history features a double bottom, with the second one occurring 3 to 8 weeks after the first and at around the same price level. If the current correction follows this playbook, a secondary bottom should occur within the next 1 to 4 weeks (i.e., before the end of March).”

There are 5 trading days left before March concludes, and given the market’s decline on Thursday and Friday (–4.0 % on the global ACWI), it looks like we’re nearing the secondary bottom for this correction, right on schedule. If the market continues to follow the typical correction playbook, once the bottom is in, a recovery shouldn’t be far behind.

Market corrections are remarkably similar. The declines are sudden and sharp, as are the recoveries. Double bottoms are almost de rigeur. Sharp price drops come out of nowhere. And they are always accompanied by a story to justify them. While the story seems plausible, the damage typically turns out to be less than anticipated.

Interestingly, there are often two competing explanations that correspond to the two bottoms. During the mother of all corrections, in August to October of 1998, the S&P 500 fell –19.9% from peak to trough. Like most corrections, it had a double bottom, one in August and the second in October. The rationale for the first was the possible implosion of a huge hedge fund, Long Term Capital Management. The second bottom was triggered by fears that Ecuador and Russia were going to default on their sovereign debt.

Long Term Capital was rescued by several investment banks and didn’t fail, but both Ecuador and Russia defaulted. Yet the world didn’t end, and the markets recovered. In fact, over the next 18 months, the S&P 500 surged over +60%. Corrections, scary as they are, can be most healthy.

The current correction also has two competing narratives. The first was a sharp increase in interest rates, as investors worried about an overheating US economy. The second narrative is nearly the exact opposite: concerns that a trade war with China will slow economic growth. Obviously, you can’t have it both ways—the economy can’t overheat and slow down at the same time. But it’s this uncertainty that causes investors to sell first and ask questions later. In the end, we may end up with a “Goldilocks” economy, with growth neither too fast nor too slow.

Our own analysis suggests the global economy is in good shape and should keep growing for a while longer. Yes, a trade war could dent growth prospects, but we believe it is unlikely to cause a recession. And a trade war is far from a done deal. So far, we’ve heard mostly bluster from both Trump and the Chinese, and we expect Trump’s tariffs against China to eventually be softened. This has already happened with the tariffs on steel and aluminum: most of our trading partners other than China have already been excluded. Likewise, we think that the $50 billion of Chinese exports subject to tariffs will be reduced as well.

Since we’re not clairvoyant, we can’t predict the future. But our analysis suggests that current anxiety is overblown. We suggest that rather than attempting to time the market, you invest for the long term and try to ignore short-term gyrations. You’ll probably sleep better as well.

 

Dr. Ken Waltzer, MD, MPH, AIF®, CFA, CFP®
Managing Director, KCS Wealth Advisory

Laura Gilman, CFP®, PFP, MBA
Managing Director, KCS Wealth Advisory

Nick Nejad, CFA
Director of Investment Research, KCS Wealth Advisory

 

 

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