The Market Downturn
Comments from our Investment Group
The U.S. stock market, at this writing is down 8% from its recent high. As we have discussed in the past, it is not unusual for a Bull Market to have a 5% to 10% correction every few quarters. The surprise is the rapidity of the decline. It has only been six trading days since the market’s peak. In the past it could take weeks or months to “correct”.
- This downdraft in U.S. equity markets is not due to any fundamental change in the outlook for the U.S. economy, the global economy or in the general health of the companies underlying stocks. In short, the fundamentals continue to strengthen across the board.
- A fundamental perspective notes that monetary policy is still in the “normalizing” phase where the Fed is slowly adjusting policy from a crisis-preventing accommodative position to a more normal “economic- cycle-smoothing” stance. The fiscal policy (government actions) has seen some deregulation and a sizable tax cut. Both are pro-business and pro-growth. Finally, corporations have changed their behavior over the last year. Revenues and earnings are increasing after several years of being flat to down, some of the anticipated proceeds from lower corporate taxes are flowing to bonuses and wage gains and finally, firms are earmarking capital projects to implement when repatriated profits from abroad become available. This is a very sound fundamental backdrop for equities.
- If fundamentals are not the problem, what is? Two things come to mind. By most measures U.S. stock prices were “fully valued” after a very strong performance in 2017. In investment speak “Fully Valued” falls after “Undervalued” and “Fairly Valued” but before “Over Valued”.
- The second thing is a little more “uncharted territory”. A lot of equity value is held in passive vehicles. This makes this decline different from the past. The speed of this market downturn is due, in part, to the growing impact of passive investment vehicles such as exchange traded funds. Like most things, exchange traded funds have their strengths and weaknesses. They provide a very efficient way of gaining diversification and exposure to various areas of the market that would be difficult and costly to obtain with individual securities. They are also efficient trading vehicles allowing decisions affecting billions of investment dollars to shift from one asset class to another almost instantaneously. Add this to computer implemented trading strategies and the possible impact on any given market is breath-taking fast. This may become the new norm.
We see the recent market downdraft as normal healthy correction in its magnitude but surprisingly swift and hopefully compressed in its duration.