Weekend Market Pullback

October 2018 | Investments

US markets have dropped over 5% in two days, should I sell?

The Dow Jones gave up another 500 points in overnight trading, on top of 800 points yesterday, and the broader S&P 500 and technology Nasdaq have given up more. Do I sell? Well, no, and here are the reasons why:

Firstly, this sell off is linked to ridiculous over-buying of the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google) and Microsoft, which at one stage this year were, as a group, responsible for most of the US stock market’s rise.

The FAANG gang accounted for 81% of the S&P 500 return this year. Adding Microsoft to the mix, you get six stocks (“FAMANG”) that account for the entire YTD return of the S&P 500.

As these companies cop an overdue recalculation of their worth, the market has to go down with them. But to keep this in perspective, a stock like Netflix yesterday was down 21% from its recent high, but was still up 70% for the year!

What’s going on now is the over exuberance taking a break, but these stocks won’t fall to nothing (like a lot of tech stocks in the dotcom crash) because they are real companies with huge revenues.

Keep in mind that the US keeps making new record highs, and so is due for a decent correction.

Secondly, after so much optimistic buying, there has to be a period where the sellers get to dominate. After the market slips 10% or so, and once overpriced stocks look like good value, rebuying starts.

A major correction in the asset markets has been building for a while. There have been 10 years of economic growth since the great financial crisis of 2008 and a bull market in stocks of pretty much the same length. That’s a long time in terms of economic cycles, and we were overdue for a “reversion to the mean,” as statisticians say.

It may feel like we’ve been thrown out of a moving car (it hurts), but that’s because the 3rd quarter was one of the least volatile quarters since 1963.

According to Peter Switzer we won’t see a quick rebound for a number of reasons:

  1. The trigger for this sell off was “how fast will interest rates rise and how much will the rise be?” President Trump blames the Fed chairman, his appointee – Jerome Powell.“It’s a correction that I think is caused by the Fed and interest rates,” Trump said from the Oval Office. “The dollar is very strong, very powerful – and it causes difficulty doing business.” (CNBC) His view is shared by the market that monetary policy looks like it might end up being tighter than expected.

    Even with his best or worst efforts (depending on your point of view), the Fed won’t delay rate rises and risk excessive inflation because that could eventually mean that bigger and faster rate rises would be necessary. There are no hard and fast rules when it comes to monetary policy, so it’s a ‘suck it and see’ thing when it comes to rate rises. The President could be wrong but he could be right!“It’s a correction that I think is caused by the Fed and interest rates,” Trump said from the Oval Office. “The dollar is very strong, very powerful – and it causes difficulty doing business.” (CNBC) His view is shared by the market that monetary policy looks like it might end up being tighter than expected.Even with his best or worst efforts (depending on your point of view), the Fed won’t delay rate rises and risk excessive inflation because that could eventually mean that bigger and faster rate rises would be necessary. There are no hard and fast rules when it comes to monetary policy, so it’s a ‘suck it and see’ thing when it comes to rate rises. The President could be wrong but he could be right!

  2. As the FAMANG story showed, a correction was on the cards. But should this turn into a crash? A 10% (or so) fall is a correction, when the market gets a dose of realism on stock prices. A crash signals that a bull market has surrendered to the bears and that starts when the market gives up 20% or more.
  3. If the US economy was slowing and company profits were under pressure, then he’d be keen to get out of stocks. But the opposite is the case. However, the China versus Trump trade war is starting to raise questions about profits of some companies being affected. The tariffs could also affect prices and then spark inflation, and the bigger US budget deficit is also suggesting that interest rates might have to go higher because of the President’s pro-growth policies.

Over the years of trying to interpret the collective mentality of the key drivers of stock prices, Switzer says he has learnt not to believe good sense will prevail in the short term.

Of course, as long-term investor, I’m hoping my analysis above is right and I’ll be able to pick up some great companies at very good prices. And one thing I must add (and I’ve referred to this before), I’ve never had to make predictions on stock markets with someone like Donald Trump running the world’s biggest economy.”

Let’s get some perspective

Today (at the time of writing) our market is down 5 points (0.1%) – a very mature reaction. We dropped 170 points yesterday (2.8%).

The wildcard is the worsening trade war between US and China which is, in fact, a worry for us all.

If you’re looking for someone to blame, here’s a list:

https://www.businessinsider.com.au/why-global-markets-are-collapsing-and-who-is-to-blame-2018-10?r=US&IR=T

What’s Next?

Friday, thankfully. But we are only in the first trimester of October and there is a midterm election coming up in the US in less than a month. That will add more volatility to the mix.

Ryan Detrick on midterms and markets:

  • Stocks tend to do very well after midterm elections. The average 12 month gain from the lows in a midterm election year is over 30%, and since 1946 the S&P 500 has never been down 12 months following midterm elections;
  • Pullbacks are normal. Even though stocks tend to average a 7-8% gain each year, they also tend to have three to four pullbacks each year (5-10% drops) and at least one 10-20% correction. We’ve had both earlier this year but history tells us we may get more.

In Conclusion

Keep in mind that we are investing for the long term, so market volatility and corrections are normal. If you are a long-term investor you have to be able to handle the dips and the rips.

For those on our Premium Investment Portfolio Service (PIPS), you will receive your full, detailed Quarterly Report and Review shortly, that will give further insight into these, and other, issues. If you’d like to know more about PIPS, please contact us.

In the meantime, if you’re looking for more material, here are some links:

https://www.livewiremarkets.com/wires/market-timing-why-it-s-in-our-too-hard-basket

https://www.livewiremarkets.com/wires/timing-is-everything

This White Paper is general in nature only and not intended as advice. All information and views expressed in this White Paper are correct at the time of publishing, 12 October 2018.

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