A correction results when stocks decline by 10% (in Wall Street jargon), and the market has reached those levels. The most widely held index, the S&P 500, was down 12% YTD earlier today. Many asset classes have dropped by at least 10%, with the Russell 2000 down 20% YTD. The big question we all face is whether we are heading into an economic slowdown and a bear market in stocks or is this just a correction that will reverse within a short time.
CNBC showed an interesting chart this morning. Since 1946, the following table shows 5-10% and 10-20% declines with the average recovery. Declines greater than 20% are less frequent and often mark recessions with longer recovery times.
Recognizing how frequent 10% declines occur, it is crucial not to panic or react too swiftly. But on the other hand, avoiding significant losses where a portfolio can drop over 20-30% or more can help maintain financial security.
Without a crystal ball, we sometimes need to adjust as market conditions change. There are likely two dominant forces acting on the market. First, we have an economic slowdown due to the rapid spread of Omicron. The slowdown affects what people spend and finding open businesses with products for sale. We expect to be past Omicron and its economic effects within the next couple of months. After that, economic growth should pick up so we would not be inclined to react to market blips due to virus effects.
More concerning and more challenging to discern is withdrawing monetary stimulus by the Federal Reserve. Declining bond purchases by the Fed and rising interest rates directly affect markets. Indeed, the more speculative areas of the market are likely to be impacted. However, this does not mean that all market sectors will sell off. On the contrary, some sectors may do very well. Therefore, we have tried to position portfolios in areas we think are likely to do well with strong economic growth, even if there is some degree of inflation.
As any football fan watching the NFL playoffs knows, momentum can change quickly, sometimes a lot faster than anyone would think possible. Today’s end of day market recovery is another prime example. So, we remain focused on the longer-term trends we find favorable but are making short-term adjustments.
Because of the sharp drop in prices across the board, we have not avoided short-term losses. However, lower exposure to growth assets helps in these markets.
Stock markets often do not correlate directly with economic strength or weakness. However, the outlook is positive, at least in the short term. Growth will continue, fiscal stimulus is in place as the infrastructure bill kicks in, the bond market is not showing signs of distress, corporate profits are still rising (on average). The market is not likely to fall apart, but recent price behavior requires continued adjustments.