TGIF – Market Correction

The Stock Market officially hit correction territory, defined as a 10%+ decline from the highs. It happened so fast, which is what always brings the panic. They are never fun. But corrections are necessary and healthy. The S&P fell 10% from all-time highs in just 9 days. That has never happened before. But, think about it: From all-time highs. If you recall, there were 66 fresh new highs last year with no mean reversion. There were 6 more in January. It was impressive but not healthy. This Market was so stretched, overbought and in many cases over-valued. We knew this was coming. It is just never clear when. Overbought occurrences can last a long time. Oversold situations occur much faster. This correction has been quicker and more violent than expected. The super strength of January led to a near freefall in February. This last happened 2 years ago to the date. 2016 was a fantastic buying opportunity.

The fact that there was no mean reversion last Summer when it should have happened made for this larger move lower. Stocks were really extended. Usually, there are 2 or 3 mini-corrections of around 5% each year. That helps diffuse the excess heat and keeps things in balance. 2017 was the least volatile year on record for the Stock Market. The historic run hit a wall last week. It’s pretty simple really; the higher it goes, the larger the correction should be. Global Markets have felt the pain as well. Technically, things are washed out and there is a lot of evidence we see that the near-term bottom is in. An over-sold bounce should come next week. But this volatile price action is going to stay. We see this choppy price action sticking around well into Spring.

Underneath the hood, things are still quite healthy. Most importantly is the Credit Markets. There is no sign of stress in the financial plumbing. That cannot be overstated. The Bond Market is generally the first thing to sniff out systemic problems. It’s behaving well. Interest rates have gone higher, which re-prices money and certainly impacts asset classes. The Market is still recalibrating strong earnings growth, an accelerating Global Economy, a little inflation and higher interest rates. It’s a process.

Investor sentiment has precipitously flipped from Bullish to Bearish. January saw the largest number of Bulls since the bubble burst. They’re not Bullish anymore. The Put/Call ratio jumped to its highest level this week since the Presidential election in 2016, as fear quickly replaced the complacency that was prevalent just a week ago. Studying investor sentiment is very helpful in identifying extremes. It’s usually a contrarian indicator. Investors generally chase performance and get Bullish late and panic at lows. The herd is on the move again. US Equity funds saw a record $23.9 Billion withdrawn by investors this week, marking the largest outflows on record. There was a record inflow into equities in December. Basically, there was aggressive buying high and now selling low. That’s the complete opposite of Investing 101: Buy low, Sell high. But emotions set in and people panic. Fear is a much stronger sensation than greed. You may recall Warren Buffett’s phrase about investing during extremes: Be fearful when others are greedy and be greedy when others are fearful. It’s often easier said than done, but history has proven it time and again.

Since 1980, 19 of the 38 years saw at least a 10% correction on the S&P 500. It averages one every other year. Importantly, 13 of those 19 corrections led to a rally which finished positive for the year. Looking even closer, the 6 that didn’t all took place during a recession. This Bull Market is up there in age, but the Global Economy is accelerating, not contracting. A 10% correction is normal and very healthy. It brings back the proper balance. It is mean reverting. And they lead to higher levels, as long as there is no recession. There is no sign of recession in 2018. If the facts change, we will too. There was an impressive reversal higher to head to the weekend in green on Friday. Next week will be telling.

There is a great deal of anxiety out there right now. It’s understandable. This is a fast moving Market. We had some hedges in place already. We increased our hedges early in the week and raised some more cash. We bought some PUTS that track the S&P 500, which is the ultimate safety net. It’s like insurance and it went up in value when the Market fell. We are very confident that this correction is a healthy one and will clear the decks for another move higher later in the year. It just needs to run its course. The Market does what it wants to do. Think of it like a massive storm that comes in and washes everything out. It’s natural and times like this, we just hunker down and fight through it. The Market is like Mother Nature. They’re both undefeated. We’ll get through this rough patch just like all of the others.

Have a nice weekend. We’ll be back, dark and early on Monday.


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