The last few weeks have seen a dramatic level of fluctuation in the stock market indexes. Speculation is rife as to the causes, but it’s safe to conclude a few things about this. First, it’s been an exceptionally long time since a significant sell-off of any lasting value has occurred prior to the first quarter of this year. Investors will recall that after the trade tariff rounds started in the early part of this year, the market regained its composure and went on to post strong gains, leading indexes to new highs just weeks ago. This current round of volatility seems to be centered on increased fears of the Federal Reserve raising rates too quickly and slowing down the economy too abruptly. And, while a trade deal with Canada and Mexico was codified, lingering trade fights with China don’t seem to be getting resolved. Also, of course, mid-term elections are causing anxiety because the current strong economic and employment performance is predicated on continuation of recent policy changes. If the Democrats take over control of Congress, concerns are legitimate that the economy will suffer again, and revert not just to the slow growth of the previous decade, but an actual recession. On the other hand, bills won’t become law if the president vetoes them. We’ll know about that outcome in a week.
But this sell-off, punctuated with recovery days, doesn’t appear to be the start of a nasty bear market. Analysis of the last 65 years of the S&P500 and the past 27 years of the MSCI All Country World markets done by Morgan Stanley, indicates sharp, initial declines are more consistent with run-of-the-mill corrections, not a slide into bear markets. And this has definitely been sharp, with the NASDAQ dropping about 13% and the S&P500 about 10% just this month. It’s scary, but not unusual. In contrast, when bear markets begin, it is with deceptively gentle declines, making it hard to discern what’s going on. Judging from history, this looks like a correction. In the ten largest 35-day selloffs, stocks ended up bouncing back in nine cases. Only one eventually turned into a bear market. The current decline ranks seventh of those ten. Our last bear market in 2007 didn’t even look like this, with no dramatic early plunges. But bear markets come along with recessions. We just received the 3Q GDP report last week, showing the economy continuing to steam along at a 3.6% rate. Unemployment remains at multi-decade lows. This is not an economy sliding into recession. For sure, eventually we will have another bear market and appropriate changes to portfolios will need to be made. At this point, this doesn’t appear to be happening now.
Bull markets don’t die of exhaustion – they die of harmful policy inputs. The smart money rides through most corrections – and this is definitely a correction – as most of them are relatively shallow and short-lived. The key for a long-term investor is to stay put and be invested when the next uptrend starts. It will come without warning and when least expected. If the slide continues to gain steam, we’ll appropriately defend portfolios.