Perspective

Market seers, including me, have been calling for a correction for as long as I can remember.  But each time the market seems poised for some profit-taking, the buyers swoop in and take the averages to even greater heights.  As of yesterday’s close, the S&P 500 was down 3.7% from its all-time intraday high of 1,991 on July 24.  The selling has produced a tidal wave of attention on the business news networks.  Will this be the time we actually see the 10% drop required to be deemed a “correction.”  While I have no idea, I do think it’s important to understand that market corrections are healthy, especially in an environment where the indiscriminate “buying the dips” has consistently been rewarded.  At this point in the bull market, we believe that investors will ultimately be at greater risk if a correction does not materialize rather than if one does materialize.

Since the S&P 500’s closing low on March 9, 2009, the index has appreciated 184%, excluding dividends.  By industry sector, the Consumer Discretionary stocks have performed best (+315%, excluding dividends) while the defensive Utilities sector has performed the worst (+81%).  These returns speak more to the magnitude of the market decline during the financial crisis than the overall health of today’s economy.  Stocks were summarily discarded during the throes of the crisis, resulting in a peak-to-trough decrease of 57% for the S&P 500 from late 2007 to early 2009.  Those industry sectors hit the hardest during the crisis (Financials: -84%, Industrials: -65%, and Consumer Discretionary: -62%) are the ones that have recovered the most since the 2009 lows.  But notwithstanding the record margins for corporate America as a whole, the business environment for banks and retailers could hardly be described as healthy right now.  As we’ve discussed ad nauseum over the past few years, the overwhelming majority of US consumers are scarcely better off than they were five years ago. A struggling middle class is not a good environment for banks and retailers.

But I digress. The factors that are currently causing investor anxiety are not a struggling consumer, but they are varied and plentiful: Russian troops amassing on the Ukrainian border; the Israeli-Palestinian conflict; an Argentinian debt default; a Portuguese bank failure; an outbreak of Ebola; the assassination of a US general in Afghanistan; ongoing conflict in Syria; and the higher interest rates that come with the end of Fed quantitative easing (QE).  If I told you at the beginning of 2014 that all these risk factors would emerge, you probably would have guessed that the market would go down significantly during the year.  Yet here we are, with the S&P 500 still firmly in positive territory (up 4%, excluding dividends, as of yesterday’s close).  Aside from providing yet another data point to support the notion that market timing doesn’t work, this year’s market action speaks to both the resiliency of the US economy as well as the relative attractiveness of the US as a home for investment dollars.

One interesting factor to note is that gold has not rallied during the course of this (so far) mild sell-off.  The price of the precious metal has been poorly bid since the end of 2012, which suggests to me that there isn’t a lot of fear or panic out there.  At the same time, though, there are some red flags to be concerned about.  Falling bond yields (the yield on the 10-year Treasury has fallen to 2.46%) and the underperformance of stocks in the Industrials sector are perhaps the most notable.  As of right now, these factors are being offset by better labor-market data and the continued presence of a Fed safety net.  But at some point, the near-unanimous bullishness for stocks will be proven wrong.  It makes most sense to remain invested but defensive as the tea leaves are interpreted.

Peace,

Michael