Now that was a bad week—and don’t be surprised if it gets worse before it gets better. The Dow Jones Industrial Average tumbled 1,095.75 points, or 4.1%, to 25,520.96 last week, its largest percentage decline in more than two years. The Standard & Poor’s 500 index dropped 3.9%, to 2762.13, while the Nasdaq Composite fell 3.5%, to 7240.95. Let’s just accept it—we’re in the midst of a correction, and one that was quite overdue. Don’t be surprised if the market’s major indexes decline by double digits from peaks hit just one week ago, as fear of missing out gives way to fear of staying in.
Ultimately, though, we’re betting that the pullback ends up being one to be bought, not sold—and it all goes back to economic data. For now, there’s no sign of a recession—the one thing almost guaranteed to cause a bear market—says Jason Pride, director of investment strategy at Glenmede. He notes that companies have been predicting solid earnings and sales for the rest of the year, something that should eventually support the market, too.
The selloff started last Monday, as bond yields began to rise, and kicked into high gear when Amazon.com (ticker: AMZN), JPMorgan Chase (JPM), and Berkshire Hathaway (BRK.A) announced plans to create a health-care company devoted to lowering costs. That news hit stocks across the health-care sector.
Then, on Friday, a better-than-expected payrolls report—one that contained signs of wage inflation—led to a 665.75-point decline in the Dow, as the 10-year Treasury yield rose to 2.852%, its highest since Jan. 22, 2014.
Based on recent trends, the market was desperately in need of a rest. The S&P 500 had gained 7.5% in just 18 trading days in 2018, putting it on pace to gain 158% this year. The index had gone 99 days without a drop of 0.6% or more before falling 0.7% on Tuesday. “This kind of thing was long overdue,” says Michael Darda, chief economist at MKM Partners.
Even great data aren’t enough to sustain stocks when the good news is already baked into prices. The Citigroup U.S. Economic Surprise Index—a metric designed to measure the extent to which economic data have been beating or missing expectations—had begun declining a few weeks ago from its recent peak. At the same time, momentum indicators such as the National Federation of Independent Business’ survey of small-business optimism have gotten so positive that they can’t get much better. Darda says. “It’s a bit foolhardy to jump on this very modest pullback as an immediate buying opportunity.”
Even after this past week’s decline, the S&P 500 has gone 404 days without a 5% pullback from its all-time high, says Chris Verrone, technical strategist at Strategas Research Partners. Such a drop would only put the index near its 50-day moving average at 2715.15. A 12% drop from the high would put the S&P 500 near its 200-day moving average, at 2532.41. “Put your thumb between those, and you get to where this shakes out,” says Veronne, who expects the pullback to be “unpleasant.”
After Friday’s drop, the S&P 500 still trades at 17.7 times forward earnings. A further drop “would reset the base for equities,” says Glenmede’s Pride. “A pullback like this is healthy.”
Even if it doesn’t feel like it right now.
(Source: Barrons Online)