There is an old Wall Street saying; “stocks go up on an escalator and come down on an elevator.” I think this market resembles how stocks went up a little at a time (like an escalator), and came down sharply in the past few weeks.

The reason why we like to take incremental gains, and rebalance is because of the escalator and elevator concept. We never know when the elevator will bring stocks down, and to what floor. Applying the theory of taking incremental gains, gives you the opportunity to buy back at lower prices when these dislocations occur; making corrections part of your overall strategy and game plan.

Week In Review:

Markets posted another week of losses amid continued fears, though markets trimmed losses on Friday on better-than-expected earnings results from top companies. For the week, S&P 500 lost 1.02%, the Dow fell 0.99%, and the Nasdaq dropped 0.42%.1

After reaching new highs in mid-September 2014, markets have been roiled by volatility and selling pressure. We know that market declines can be nerve wracking and we wanted to take the opportunity to discuss the recent pullback with our clients.

Market Corrections are Normal

Since 1928, the S&P 500 has generally experienced between three and four corrections of more than 5.00% each year; the October pullback was the 20th decline of 5.00% or more in the current bull market.2 Declines of 10.00% or more are rarer, but are still seen nearly every 1½ years.3 Obviously, these are all averages and the performance of any single year can deviate significantly from historical norms.

In the current bull market cycle, markets have experienced just two declines of 10.00% or more: in Spring 2010 when the Federal Reserve launched its quantitative easing programs and in Summer 2011 when the euro appeared to be in trouble.4

Putting the Current Selloff Into Perspective

After a lengthy period of market gains – between January 1, 2013 and September 19, 2014, the S&P 500 gained 43.35%5 – many analysts were confident that a selloff had to happen eventually. The current selloff has largely been spurred by a combination of global worries: recessionary fears in Europe, slowing growth in China, some disappointing domestic economic reports, and Ebola concerns all contributed to the drop.

How far equities decline during a selloff depends on a lot of factors, including investor sentiment, corporate earnings, economic data, and growth prospects for the near future. In this case, markets are largely moving because of fear, not because of fundamental factors, so we can hope that the selloff will be brief. Although we ended the week with a loss, equities halted their slide on Friday and regained ground on the strength of recent earnings reports.6 Is the decline over? Hard to say.

Though the past can’t predict the future, we can look back at past market declines for hints of what we might expect going forward. Since 2009, pullbacks of 5.00% or more have lasted an average of about a month, peak to trough, meaning that the recent downturn may not be completely over.7

As of Friday’s close, the S&P 500 was down 6.19% since its peak in mid-September.8 Markets have gone 1109 trading days since the last 10.00% + correction. Since the average is around 509 days between corrections, we might be overdue. However, we went more than 2,500 trading days between corrections in the mid-nineties, so there is precedent for the winning streak to continue.9 Let’s also keep in mind that although the S&P 500 has lost ground this year and is hovering around 2.00% return, it’s still up more than 8.00% since the same period last year.10

Looking Ahead

The week ahead is thin on economic data but earnings season will be in full swing, which means that positive earnings could override fear-based selling. However, global worries still exist and it’s unknown how long the present weakness in the market will continue. We can hope that lower equity valuations, decent corporate earnings, and seller exhaustion will help push investor sentiment into positive territory as traders “buy the dip.”

Though some economic headwinds exist, we believe that slowing growth in Europe will have only a modest impact on the U.S. economy. Declines in oil prices may be a net positive for the economy as consumers have more money to spend; weakness in the euro should help European exports and mitigate recessionary fears. Corporate earnings appear to be reasonably decent, which should also help spur market growth. While we can’t predict the future, we believe that economic fundamentals are solid and favor continued market growth.

Conclusions

Though market corrections are rarely welcome, they are a natural part of the overall business cycle and it’s important to take them in stride. Declines also provide an environment to test your risk tolerance and ensure that your financial strategies and asset allocations are aligned with your long-term objectives and appetite for risk.

As professional investors, we’ve learned to seek out the opportunities in market corrections and volatility. Declines often create openings for tactical investing and allow us to invest in high quality companies at attractive prices. While we can’t use the past to predict the future, history tells us that having the patience to sit out brief rough patches often benefits our clients in the long run.

We hope that you have found this information educational and reassuring. If you have any questions about market corrections or are concerned about how the recent pullback may have affected your portfolio, please give us a call. We are always happy to speak with you.


1 http://bit.ly/1vEcUUK
2 http://usat.ly/1uvTi0I
3 http://read.bi/ZDrwa9 , http://bit.ly/1fHYvPa
4 http://www.cnbc.com/id/102090443
5 http://bit.ly/1onKDBb
6 http://www.cnbc.com/id/102097314
7 http://usat.ly/1uvTi0I
8 S&P 500 performance between 9/19/14-10/17/14 – http://bit.ly/1uvTQDQ
9 http://bit.ly/1r3Bglq
10 S&P 500 performance as of 10/17/14 and between 10/21/13-10/7/14 – http://bit.ly/1ycuQW1

 

The information in this article is not intended to be tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2014 Emerald Connect, LLC
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