Is This Time Different? A Brief History of Messy Corrections
–December 13, 2018
“The big money is not in the buying and the selling, but in the waiting.” – Charlie Munger
“The stock market is designed to transfer money from the active to the patient.” – Warren Buffett
I know I’ve shared those quotes before, but they are particularly important to keep in mind during periods of volatility.
There has been a lot of talk in our highly excitable media over the last several weeks about how bad things are between trade tariffs, slowing growth, yield curve gymnastics, Brexit, Italian Debt, political uncertainty, so called “Death Crosses”(when the blue line goes below the red in the graphs below) and a whole bunch of other things which all seem scary and full of portent. The talking heads are doing their bit, and the rest of the financial media is full of dour predictions and visions of bear markets.
People have been rattled, and we now find ourselves in the midst of a correction that feels even scarier than the headlines to many investors.
But let’s take a step back and think about what is happening. Then let’s see how the market behaved when investors were cringing from headlines like what we are seeing today. As has been observed by those wiser than I, “history doesn’t repeat, but it rhymes.”
In the summer of 2011, the headlines were full of the European Debt Crisis, political disorder, growth fears, etc. with the market coming off a post-recession high (much like today) amidst talk of poor value.
Some sample headlines from that summer:
- “Demonstrators Marching to Brussels to Protect Effects of Crisis”
- “US Accuses Tehran of Secret Deal”
- “Stocks Nosedive After US Credit Rating is Lowered”
- “Budget Talks Heat Up as Debt Ceiling Deadline Nears”
- “Job Growth Continues to Stall”
- “Economic Cycle Research Institute Forecasts US Recession in Months”
- “A Death Cross for the S&P 500 Highlights a Stock Market in Tatters”
- “Stocks Overvalued by 45% According to C.A.P.E. Ratio”
The economic (fundamental) situation:
- Low interest rates
- Slowly growing economy
- High unemployment
- Low inflation
- Moderate but inconsistent earnings growth
- High Corporate and Personal Taxes
And of course, a long, messy correction that did a great job of scaring everyone and causing talk of recession and bear markets.
Any of the above sound familiar?
Here is a chart of the 2011 correction.
Notice how the price of the S&P jerks up and down over a 4-month period (late July to mid-December), including making a lower low two months after the initial low before beginning to recover in December. The correction lasted from the end of July until a couple days before Christmas. Daily moves were regularly in the 1.5% range in either direction and moves of + or – 3%+ often occurred.
A careful market observer might notice that this correction looks an awful lot like the one we are in right now, including the “Death Cross” that gets the media gushing.
An even more careful observer might notice that fundamental economic conditions are significantly better right now than they were in July 2011. The market is also a heckuva lot higher. Those who got shaken out, missed out.
Let’s fast forward to summer 2015. A slowdown in Chinese growth and renewed fears of European Debt contagion were the catalyst for the media doom frenzy this time, and the market was again coming off a new post-recession high.
Headlines:
- “Millions Exposed to Computer Hacking Linked to China”
- “Greece Misses Debt Payment”
- “UNHCR Report Reveals Record Number Refugees”
- “Immigration Crisis Intensifies”
- “US Government Shutdown Looms”
- “September Jobs Report Disappoints”
- “Oil Prices Fall 30% in August”
- “Chinese Devalue Yuan”
- “Dow Falls Nearly 1900 in 5 Days”
- “Citi: There’s a 65% Probability the US Goes into Recession in 2016”
- “Jobs Report May Lead Fed to Raise Interest Rates”
- “The S&P Death Cross — Time to Panic?”
- “We Are In a Bear Market”
- “The Bear Market Has Begun”
The economic situation:
- Low interest rates
- Slowly growing economy
- Moderate Unemployment
- Low inflation
- Low-to-moderate but inconsistent earnings growth
- High Corporate and Personal Taxes
Here’s the chart of the 2015/2016 double dip correction.
Here we see a pretty serious correction in the market (about -13%), followed by what appears to be a recovery, followed by another serious market correction, (again about -13%) about 3 months after the first. The 2nd actually went very slightly lower than the first correction although it doesn’t show on this chart. Note the presence of not one, but TWO of the dreaded Death Crosses. (Yes, said with a bit of sarcasm).
And now let’s move forward to today, where the market is more than 26% higher even with the current correction. I won’t bother listing out headlines as they are probably fresh in your memory, but they include China, European debt, US Government shutdown, Brexit, refugees, falling oil prices (actually good for US consumer), bear markets, recession predictions, yield curves and a partridge in a pear tree.
Yet:
- Low Interest Rates
- Stronger growth in the economy than we’ve seen in a decade
- Record low unemployment
- Low Inflation
- Respectable (and solid) earnings growth
- Much lower Corporate and Personal Taxes
Here is a chart of the current market (2018):
If you have a careful look at the charts of each of these periods, you see clear similarities. Charts aren’t good for much except tracking the emotion of crowds – in this case crowds of investors. As we all know, crowds are dumb compared to individual decision makers.
Will this time be different? Will the fears of the crowd somehow determine the direction of the economy and the market despite the stark (and positive) reality of the underlying data?
I suppose anything is possible. But if volatile corrections in the past with much weaker economic backdrops and equivalent risks didn’t manage to usher in a bear market and a recession, the odds say they won’t manage it this time around either.
That’s not to say things couldn’t get worse in the near term. Investor emotions can do amazing things in the short term as we saw in 2011 and 2015. Fear is in the driver’s seat right now.
But the idea that anything other than hard economic data determines the overall direction of the market for more than a few months has been repeatedly debunked. Fear doesn’t have staying power.
When the economy is expanding (even slowly), inflation and interest rates are low, and earnings are growing, the investment environment has nearly always rewarded rational investors.
If there is anything the market teaches us, it’s that deciding “this time is different” is almost always a bad idea.
Corrections, however messy, are not a time to sell – they area time to get free cash to work. Risking down is a sport savvy investors only play in the beginning of a confirmed recession. That hasn’t happened.
So are there any real risks out there? As I see it, there are 4.
1. The first is the short-term memory of investors may kick in spring 2019 when Q1 earnings from 2019 are compared with Q1 earnings from 2018. There will be a big decline in earnings growth rate. That’s due to the earnings bump from the Tax Act for 2018. Rational investors will not be interested in that comparison. Rational investors will subtract out the earnings bump from the Tax Act from Q1 2018 to compare the true growth rate, which is likely to be in the 5%-7% area, which is supportive of the market. But in the short term, the market is rarely ruled by rational investors – that may bring another bout of volatility. A third 10%-15% correction in less than 12 months seems likely to cause investors to batten down the hatches and de-risk.
2. There are potential liquidity issues underlying segments of the market. A third serious correction in less than 12 months (if it occurs) may see these pressures come to the fore.
3. The Fed may not be as dovish as it currently appears and raise rates three or four times next year. I think the economy can take two rate hikes without issue. Three is pushing it, and four may cause investors to risk down aggressively in early preparation for a recession. This will bear watching.
4. The 4th risk is, of course, that the US moves into recession. At this point, that does not look likely, but the data may change.
As a side note, I’ll also point out that the financial media reports in cycles designed to encourage investors to transact (which creates dollars for their financial company advertisers) – meaning that at some point, maybe soon as 10 weeks of fear is starting to push it outside a real recession, the media narrative seems likely to shift to bullish.
The Jim Cramers of the world seem likely to be talking about market “bottoms” and pounding the table about stocks you have to buy in banking, technology, consumer discretionary, biotech despite their dire statements of bear markets and catching falling knives a few weeks ago.
Please get in touch if you have questions or concerns. The same if you’d like to discuss your current portfolio or if the current volatility is weighing on your mind.
Health, happiness, and a wonderful holiday season to all.
Dak Hartsock
Market Strategist
ACI Wealth Advisors, LLC
