Earlier this week we sent out a note regarding the Dow’s “biggest point loss in history” (although it does not crack the top 100 declines in percentage terms) and how computerized trading strategies related to volatility seemed to be driving extremes in market movements. After another significant decline on Thursday, most U.S. stock market indexes have entered “correction” territory which is defined as a 10% decline from a recent high.
According to research from Capital Group, a correction of approximately 10% happens on average once per year. What’s odd about this correction is how fast it has happened – the Dow hit an all-time record high on January 26th and has taken only nine trading days to reach “correction” territory. Prior to this decline, the market set multiple all-time records for low volatility. Going from one extreme to another in only nine trading days definitely puts more emotion behind the correction.
As we’ve stated in the past, it’s our job to be unemotional and look at the facts. The Joseph Group’s Investment Strategy Team met this morning and here are some of our observations:
- We continue to believe the stock market decline is more technical rather than fundamental in nature. The economy and corporate earnings remain strong.
- Despite the decline in stocks, “credit spreads” on risky corporate bonds have been relatively subdued. This is a sign to us, at this point, the bond market does NOT seem to be very concerned about a bigger economic or banking system impact.
- Data shows investor sentiment, which was close to all-time highs for “extreme optimism” nine days ago is back to more “neutral” levels.
- Stock valuations as measured by P/E ratios are no longer “overvalued.” The combination of increased corporate earnings estimates from tax reform and lower stock prices has forward Price to Earnings (P/E) ratios in the range of 16 to 17 – a level which is historically associated with “average.”
- According to Capital Group, when the market has a correction of 10%, the average recovery period is about 115 days.
With the above in mind, at present, we view the recent decline as an opportunity. This correction could have more time to play out, but, in the days ahead, we are looking to invest cash and add stock exposure where appropriate in client accounts. At the same time, we are being diligent in looking at the data for signs this sell-off could get worse. Our investment committee has plans for what we want to buy to take advantage of opportunity, but we also have contingency plans for what we may want to sell in case we need to pivot and reduce risk in client accounts.
We welcome your comments and questions as we continue to seek to manage risk as well as opportunity as we focus on meeting the goals and objectives of our clients.