Stock investors, take a deep breath and repeat the following: This is not the beginning of a bear market. A recession is not at hand.
So don't sell now. But don't say you weren't given fair notice.
Back in August here, and throughout the summer in my stock newsletter, Brush Up on Stocks, I wrote it was time to sell stocks and book cash ahead of a probable autumn rout.
Investors seemed too bullish back then. And the ghosts and goblins often come out to spook the markets in October.
Now, here we are.
If you did not sell along the way, it's too late now. At this point, it's best to hold on tight and do what you can to avoid getting shaken out of stocks in a panic, even if it means turning off your computer and going for a walk, as a way to manage your emotions — the biggest enemy of successful investing.
If you did sell and raise buying power, now it's time to begin deploying it. The reason is simple. Recessions are what normally kill bull markets — and a recession is not likely for at least a year or more. So the current sell-off gives you a chance to buy stocks at better valuations.
"The economic fundamentals remain favorable," said Bruce Bittles, Robert W. Baird's chief investment strategist, after Wednesday's sell-off. Bittles was also cautious on stocks ahead of the current rout. "Given the strength in the labor markets and confidence levels among small businesses, the odds of a business turndown are unlikely. We remain bullish on the U.S. economy."
Another investment chief I spoke with had a similar opinion.
"We're not overly worried about this being the early legs of a large-scale market correction in conjunction with a recession," Joe Mallen, chief investment officer at Helios Quantitative Research, said Wednesday. "I don't see anything so dire from an economic data perspective that will create a 20% plus drawdown. I think this is very technical in nature."
Mallen cites consumer confidence levels near all-time highs and third-quarter GDP growth projections at a healthy 3.3%. Mallen also notes the spread between high-yield corporate bonds and 10-year U.S. Treasury notes remains relatively contained at around 3.6 percentage points. Normally this spread blows out when severe trouble lies ahead for the economy and stocks.
None of this means stocks were at a bottom Wednesday. At this point, we may need the classic "big puke moment" of capitulation to wipe out the remaining weak hands, restore enough fear and respect for the market and clear the air. No one knows when that will happen. But watch for a big whoosh down at an open, followed by a quick and sharp reversal, and some gains.
Bittles thinks the S&P 500 (.SPX) will test its February lows of around 2,600 points. Mallen thinks there will be a 10%-12% drawdown, which would take the S&P 500 to about the same level that Bittles cites.
Learning from 1987
Leuthold Group chief investment strategist and economist Jim Paulsen was cautious about stocks ahead of the January-February rout. And he remained steadfastly cautious in front of the recent sell-off. He's made a lot of good market calls like these in the 20-plus years I've tracked his work and known him. Now in the current weakness, he's turning more bullish on stocks.
"We might have a gut-check correction, but that might be a good buying opportunity for another good run," he says.
Following the October 1987 correction, the bull market lasted for another two years, Paulsen points out. "The opportunity from the bottom of that correction to the top was quite substantial." Paulsen thinks a repeat is possible, even if the bottom-to-top gains might not be as large.
One reason is that a sharp enough decline in stocks and bond yields, as investors turn to bonds for safety, could lead the Federal Reserve to become less aggressive on rate hikes. "The odds are that we elongate the recovery," he says.
Get used to volatility
The current sell-off comes as a shock to investors who have grown accustomed to the eerie market calm and steady gains during much of the administration of President Trump. But this volatility is something you should get used to because it's more typical of the advanced stages of a bull market, says Robert Bacarella, founder and chairman of Monetta Financial Services, who helps manage the Monetta Fund (MONTX) and the Monetta Core Growth Fund (MYIFX).
Bacarella agrees that the current selling is not the start of a bear market. So he's watching FAANG stocks and tech stocks, such as Amazon.com (AMZN), Alphabet (GOOGL), and Adobe (ADBE) for roughly 5% declines below where they traded Wednesday, to add to those names. He says he'd add Apple (AAPL) if it fell another 13%. "These are important support levels."
Bacarella cautions against moving money into defensive names like consumer staples. They've been bid up. And you probably won't get out of them in time.
"Historically, the average bear market has lasted only 71 days," he says. "As a result, most investors miss a major part of a market rebound when they shift into defensive sectors. They are slow to shift out of these defensive sectors and typically will lag overall market returns. We seek to consolidate into selected high-quality growth companies during market corrections."
The Trump effect
Of course, all of this assumes a recession is not at hand. But that's Bacarella's base-case assumption. He believes the tax cuts orchestrated by Trump have extended the bull market by a couple of years. "The bull market that started in 2009 is still intact," he says.
Nuveen Global Investments chief investment officer Jose Minaya agrees that the tax cut and federal spending stimulus dumped on the economy by the Trump administration lowered the odds of a recession in 2018 and 2019. "Our equity portfolios are still positioned for a risk-on environment in the medium term," he says.
Monetary policy also continues to support economic growth because the real federal funds rate (after inflation) is zero, points out Darrell Riley, a strategist at T. Rowe Price. "The economy has a lot of momentum going into next year and monetary policy is still stimulative," he says. "The economic cycle may go longer than we think. And a lot longer than we think."
All of this may seem improbable, given that we are nearly 10 years into the current bull market and economic expansion. That is a long time. Expansions and bull markets normally don't last longer than this.
But as Sam Stewart of Seven Canyons Advisors points out, it's never the clock that brings an end to an economic cycle. "It's always excesses," he says. Stewart sees "a hint" of excess here and there. But nothing like what we saw leading up to the housing-related market crisis 10 years ago. The kind of excesses that typically bring down the economy and the market may still be years away, he says.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested AMZN and GOOGL in his stock newsletter Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.
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