The 2018 Stock Market Correction
Contributed by Doug Walters
In February of 2016, armed with spreadsheets, fundamental research, and a keyboard we made our case for adding to stocks in the face of weakness (Why We Are Buying, 2/16). Today, as we watch stocks fall into correction territory, we see another opportunity for long-term investors to take advantage of increasingly attractive stock prices.
The Correction by the Numbers
From their September 24th highs, the S&P 500 has fallen 18%. Year-to-date, stocks are down about 8%. From September of last year, stock returns are zero, so equity investors have seen over a year’s worth of returns disappear.
Why the Sell-off
The primary concern for investors is that the economic cycle has peaked. Media outlets are flush with other explanations, such as:
- U.S. budget and the potential for a government shutdown,
- weakness abroad (France, BREXIT, etc.),
- the Federal Reserve raising rates, and
- trade and tariff wars with China.
While these events are meaningful, we believe the underlying concern is that the economy is peaking and that some combination of the above headwinds could be the tipping point for the U.S. which has enjoyed over nine years of expansion.
Under the covers, there are other factors that have market watchers on edge. Unemployment is very low. While this is generally a good thing, if the labor market is too constrained it will likely lead to higher wages and therefore lower profitability for companies.
Adding to the peak cycle argument is the all-too-often-heard logic that after nine years of growth we are “due” for a recession. The memories of the 2008 financial crisis are still burned in the mind of investors, and many have been waiting for the next shoe to drop ever since. Thankfully economies do not work this way. Just ask Australians who have not seen a recession since 1992!
The economy is strong and expanding
- Year-on-year growth of GDP has been rising for the past two years, giving no indication of an impending slowdown.
- U.S. economic leading indicators (which are designed to foreshadow cycle moves) are high and trending upwards.
- U.S. companies are expected to report 6% sales growth and 12% earnings growth in Q4.
Stocks are entering value territory
- The robust economic growth paired with the declines in the stock market have resulted in sharply lower stock valuations.
- Large-cap are the cheapest they have been since 2013, while small-cap stocks have not been this cheap since 2010.
- Large and small cap stocks are trading below their 20-year median valuations.
As an investor it is important to submit to the following facts:
- We have no crystal ball. We cannot predict the future; we can only prepare for it.
- We cannot control the market. It may continue to fall, and that is okay (it will eventually go back up).
- It is human nature to run in the face of loss. Trying to time the market by exiting equities is gambling not investing.
In times like this, we take comfort knowing our clients are well-positioned for the ups and downs of the market. A diversified portfolio, set to the investor’s unique risk tolerance, grounded in quality and value, is designed to survive market sell-offs, and flourish when stocks rebound.
We see opportunity in the current market weakness and are adding to U.S. equities, and particularly small-cap stocks. It is possible, despite robust fundamentals, that the market continues to slide. There is no reason to fear that scenario. We are content to own more stocks at an attractive valuation knowing that sticking to a disciplined process, grounded in fundamentals, is in the best interest of the long-term goals of our clients.
Happy Holidays from the Strategic Investment Team!
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