Stock Market Correction – Should We Be Worried?

Over the last couple of weeks the attention of many investors has been captivated by headlines and talking heads on TV discussing stock market gyrations. Yes, we have seen major indexes drop by as much as 1,100 points and more. Yes, we have seen interest rates go up. The important step here is to determine what really matters and what does not – we will refer to irrelevant things as “noise” going forward.

First, let’s focus on things that DO matter but are dry, boring, and do not turn heads or sell ads like a video of someone ripping their hair out on the stock exchange floor. To determine how healthy the economy is, one should look behind headlines and monitor the unemployment, small business optimism index, Institute of Supply Management Purchasing Managers Indexes – manufacturing and non-manufacturing, etc. Keep your fingers on the pulse of the economy and go directly to the sources for information.  This will enable you to have a more accurate picture without having your emotions manipulated by the media whose primary purpose is to generate revenue from advertising by increasing their audience.  Finally… it will enable you to make smarter investment decisions.

What does NOT matter and should be avoided by most investors is the noise generated by the media. TV Stations and newspapers have one primary purpose – to sell advertising. As most of us would agree, the days when the primary purpose of the news media was to objectively report the news are long gone. To sell advertising, the media must maintain the attention of their viewers or readers, and keep them coming back for more day after day. Nothing accomplishes that goal better than playing on the fear and greed of their audience – and sensationalizing everything that plays upon these two emotions is an effective way for the media to keep their audience tuned in day after day.

Instead, let’s take a look at the current state of the Economy.  The Small Business Optimism Index is a great tool to measure the outlook within most “Main Street” businesses.  According to the January 2018 survey, a record number of small business owners reported that “Now is a good time to expand” setting the expectation of future expansion at a 45-year high. Additionally, the four week moving average of weekly unemployment claims suggests we are currently at a near-record low. If we add readings from these two indicators together we see that the labor force is at a very high utilization level – which suggests as business owners struggle to find qualified employees, wages must increase. Higher wages typically lead to an increase in the rate of inflation.  Typically, the Fed’s response to higher wages and inflation is to raise interest rates, thereby reducing the rate of economic expansion. Concerns over inflation and interest rates are healthy and natural by-products of a strong economy. A flattening yield-curve, increasing inflation, and rate increases by The Fed are telltale characteristics of an economy that is approaching the end of its business cycle. At some point, the party will end, and a recession will follow. However, based on all the indicators we currently have, that time is not here yet; we should still have a good year or two ahead of us before the cycle ends and recession looms.

Next let’s take a look at current stock market gyrations.  Is this correction a precursor to a recession? Is it instead merely  a normal correction? Recessions are temporary economic declines (10 months on average) during which businesses contract, unemployment increases, prices and wages contract, The Fed responds by interest rates ... and stock market tumbles. Admittedly, all of these things are negative. The silver lining is that recessions are not unexpected surprises, but instead are cyclical events that are part of a natural business cycle. That being said – if one keeps close watch on the health of the economy and recession indicators, it is possible to estimate when to expect a recession and adjust their portfolios accordingly. We’ve already seen strong economic data, without any real hint of a slowdown - leaving us with the most likely conclusion that the current market volatility is merely a stock market correction.

A market correction is defined as a decline in stock, bond or commodity index of at least 10%.  These are relatively frequent events that occur almost every year.  We have had 36 such corrections since 1980. Another bit of good news is that corrections rarely last long.  Since 1945, the average length of a correction in the Dow has been 105 days. Unlike a recession, stock market corrections are random events typically ignited by a short term concerns, and generally cannot be accurately predicted. By its very nature, the stock market does not trade on present day company valuations; instead, stocks are typically priced on forward looking expectations. When the economy is doing really well, as it is now, the broad stock market can get a little bit ahead of itself. It is normal for a stock market to remain overvalued for prolonged periods of time in bull markets because of investor’s expectations of higher earnings in the future - but if something unexpected happens that has not been correctly priced into future valuations – the stock market reflects investor opinions of new valuations that include this newly provided information. The present day correction has been triggered by an unexpected increase in the rate of inflation and the increased probability of more aggressive Fed actions than previously anticipated. Since corrections are unpredictable and the majority of data suggests that market timing as an investment strategy does more harm than good – it is our belief that investors should remain invested, let the 105 days pass and allow portfolios to recover.  Likely this correction, as many others in the past, will soon be a distant memory and have little real effect on the lives of long-term investors.

Michael Mikonis, CFP® is a Financial Advisor and an Investment Adviser Representative of PARAGON Wealth Strategies, LLC.  His full bio can be seen here: https://www.wealthguards.com/michael-m-mikonis-cfp

 

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