Checking in on the Stock Market: The Downward Slide Continues

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Nov 15, 2018 1:06:41 PM

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stock marketI want to take a break today from the next world discussion to check in on the stock market. Since the pullback in October and the bounce after the midterms, we have seen a slow and continuous decline. I have been hearing more questions and concerns, so let’s take a look at what is going on.

The big picture

First, as usual, let’s evaluate the big picture. The S&P 500, which is the best index to analyze, is now down a bit more than 8 percent from its recent peak in mid-September. At its lowest point, on October 30, it was down slightly more than 11 percent, but that was during the day. On a closing basis, the lowest decline was a bit less than 10 percent, also on October 30, as the market rallied somewhat from that day's low.

Looking at these aggregate numbers, we either just barely had a correction (i.e., a 10-percent pullback) or just narrowly avoided one. Right now, we have moved further away from one. Still, is a market correction a worry?

Not really. Corrections are normal. In a typical year, the market pulls back by more than that at some point. Not every year, of course. But, on average, we get a 14-percent pullback every 12 months or so. By this measure, we are right in the normal range, and there is nothing to worry about. The recent pullback, while sharp, is very like the one we had earlier this year, back in 2016, and at many other points. From a big-picture perspective, it is not yet time to worry.

The technical picture

Now, the technical picture is slightly more worrisome. Even here, however, the news is not a reason for too much concern. The S&P 500 broke below its 200-day moving average, true, but that is when I start to pay attention—not when I start to worry. Based on history, that break happens reasonably frequently; however, more than two-thirds of the time, the market recovers and moves higher. As I said, this indicator is something to watch but not yet worry over.

The break on October 11, however, was starting to look bad, especially when the S&P continued to drop down and close in on the 400-day moving average. This move is a much more reliable signal of a bigger drop ahead. But, in fact, the market turned back up before getting there and remains well above that point. I am therefore still paying attention but still not too concerned. The 400-day moving average is now at 2,645 for the S&P 500. Should the index drop down to that level, it will be time to pay much closer attention. We are not there yet.

What else should we be watching?

With the market down (but only by normal levels) and in the technical territory of pay attention but don’t panic, what else should we be watching?

Economics and earnings are what fundamentally drive the market, and here the news is more encouraging. Economic growth remains healthy, and all the major indicators are green. Corporate revenue and earnings growth are also strong. While there are some signs of slowing, the market looks reasonably priced based on recent history. This news is encouraging.

Although the fundamentals are strong, we need to watch the market itself, as that will tell us how investors are thinking. We could certainly see more downside, for example. In fact, as the slide continues, that scenario becomes more likely. And whether that slide continues will reflect whether investors as a group remain confident. With some seasonal tailwinds coming into play and with corporate stock buybacks scheduled to pick up again, a continued slide through early December would be a signal that market confidence might have changed in a more durable way than we now see—and would be a sign that we need to take a more defensive stance. That change could certainly happen.

Focus on what matters

It has not, however, happened yet. Remain calm, remain alert, and remain focused on what matters—because the daily price movements do not.

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