Waiting for the ephemeral correction has been like waiting for Godot. Okay, so maybe it’s been more like waiting for your next dentist appointment (apologies to all dentists) or colonoscopy. You knew it wasn’t going to be fun, and you knew the time would come eventually. While painful in the short-term, they make the patient healthier for the longer-term.
The average year typically has more than 1 stock market correction, defined as a drop of more than 10%, and yet we haven’t had a true market correction since late summer 2011. 4 years is a very, very long time between corrections. What causes corrections? There’s generally a nagging concern that suddenly becomes an acute concern. We wrote an extensive blog post on our website last October, in the midst of a nearly 10% drop in the market:
Is it Correct to Call this a Correction?
This year, it’s been the meltdown in commodity prices (including oil) and emerging market currencies and stock prices. While all these had been steadily falling this year, they took on a new trajectory when China suddenly devalued its currency 2 weeks ago.
This is where we remind you that every scare in the market is caused by an uncertainty that people have trouble wrapping their arms around. Yes, we’ve seen emerging market currencies crash before. It’s not pretty, but the 1997-98 experience shows us how the U.S. economy skated through it pretty much unscathed. But in this economic expansion, China has been the driving force of global economic growth. Did China tip its hand when it devalued that it is seriously concerned about its growth? If so, what (who) will keep the global economy afloat?
Yes, there will be another global recession someday, and another recession in the U.S. We don’t think it’s in the near future. The economic expansion that started here 6 years ago (6 years ago!) has been so slow compared to past expansions. 6 years into past expansions, there are typically some parts of the economy that have become overheated. Like tech or real estate. Yes, you could say commodities are this cycle’s boom and bust, but the overbuilding of the commodity complex never really came to the U.S.
This cycle has featured a pervasive sentiment of skepticism that continues today, which has prevented any excesses from building in our economy. Just ask the Fed! Our economy right now features healthy consumer spending, buoyed by healthy employment growth. Corporate profits are being dinged by the strong dollar and weaker capital spending, but are still projected to be up slightly this year. Sales are growing, and wage growth is still tame, so profit margins are intact. The housing sector is starting to stage a rebound. The budget deficit continues to shrink. The trade deficit even looks decent, thanks to the sharp drop in import prices (thank you, Saudis). We believe these strengths will continue to underpin the Goldilocks economy (not too hot, not too cold), and we still think the most likely end of the expansion will be caused by the classic combination of an acceleration in wage growth, combined with the Fed tightening interest rates too much. But we don’t see these as imminent, and anytime a global economic concern surfaces, it simply pushes off the likelihood of our economy overheating even further into the future.
Staring up at Dow 18,300 from Dow 15,800 is not fun. That’s a 14% drop. It’s much nicer to have a correction come AFTER a big bull run to start the year, so the correction merely erases the gains. We don’t have that luxury this year, but remember that the market rose more than 70% since the end of the last correction.
Where will the market go next? As we go to “print,” the market is up 2% this morning, but expect volatility to continue in both directions for awhile. With steep corrections like this one, the sharp initial correction is typically followed by a bounce back up, which then peters out. The market fades, then drops back down to “retest” the lows.
As for whether Donald Trump or any other presidential candidate is to blame for market volatility, we’ll leave that to your opinion. But we do know that the 3rd year of presidential cycles is typically the best of the 4 years, and we haven’t seen a loss in any 3rd year since 1939! That’s 18 straight years of positive returns, and an average of a 20% gain those years. At this point, we’d take any gain!