In truth, I don’t know — nor does anyone, but the weight of the evidence suggests to me that we are simply in a normal correction, albeit one that has been sharper than usual, explains John Boyd, mutual fund expert and contributing editor to Fidelity Monitor & Insight.
There is no end to the list of worries blamed for the selloff, but the fact is that virtually all of them have been with us for some time. Nothing has fundamentally changed in the backdrop for stocks. The severity of the declines has been largely driven by algorithmic traders.
Once the markets dropped below their long-term trend lines, they automatically switched from buying the dips to selling the rallies (thus we have seen a pattern of solid openings that reverse before the day is out).
In a recent Barron’s interview, legendary investors Steve Einhorn and Leon Cooperman of Omega Advisors hedge fund, who have trounced the market for almost 20 years by paying heed to the approach of a bear market, gave their checklist for a bear: 1) problematic inflation; 2) tight monetary policy; 3) recession threat; 4) investor exuberance; and 5) high valuations.
Let’s take a look. Inflation, while generally moving higher, is still well contained with the core CPI for September at 2.17% — just slightly above the Fed’s target.
As for the Fed, while it has been raising rates and expects to continue doing so, current rates are not tight. With the Fed funds rate at 2.25%, the “real” rate (subtracting inflation) is essentially zero. Real rates would need to be much higher in the 1.50% to 2.0% range to really pinch the economy.
Right now, the economy remains strong with third quarter GDP growth estimated at 3.5%. There are some concerns in the internals of that report, (notably a build up of inventories as firms stockpile what they can before new tariffs kick in), but the risk of a recession near-term is quite low.
As for investor sentiment, we have not seen anything that would indicate investors are overly exuberant. Leading up to the current swoon, bullishness in the weekly American Association of Individual Investors (AAII) poll was below its historical average. In fact, doubt about its durability has been a hallmark of this bull so far. CNN’s fear and greed index, neutral a month ago, is now in extreme fear territory.
Heading into the correction, valuations on the S&P 500 were roughly in line with their historical average with a 12-month trailing P/E of 19.4 versus 19.2 over the past 25 years. Thanks to the October plunge, that P/E has now fallen to 18.1.
In short, the conditions for a bear market are not yet present. I don’t know when this correction will be over, but I suspect it won’t be until after the mid-term elections. Some good news on trade negotiations would help, too.
In the meantime, don’t let all the negative news cause you to panic (don’t check your portfolio’s value after every drop!). If you just can’t stomach the volatility, consider switching to one of our more conservative models rather than simply dumping all your stocks for cash.
