Market decline

Despite Dow Jones Rebound, Stock Market Decline May Not Be Over Yet

Historical data is a reminder that the stock market may get worse – or at least go sideways – for a while. But it also confirms what many long-time investors will tell you: don’t panic. After a massive rise in stock values, that’s probably pretty healthy.

“I don’t think the decline is over,” said Kristina Hooper, chief global market strategist at Invesco. “Valuations are still stretched.”

The Dow Jones rose about 26% from January 2017 to January 2018, an increase that is more than three times the typical annual gain of 8%. That’s why pretty much everyone was saying we were overdue for a correction.

On top of that, some individual stocks were particularly overfed. Netflix, for example, was up more than 40% in January alone, and Boeing jumped more than 20% last month. Even after the pullout, Netflix and Boeing only returned about 5% of the massive gains.

“We had stocks that had moves in January that you just can’t sustain every month,” said trader Tim Anderson, managing director of MND Partners.

The market isn’t really cheap yet, but it’s much closer to the normal price than it used to be. A popular indicator of market dearness – the “P/E ratio” – looks at stock prices divided by expected earnings. The P/E ratio was 18.2 before the recent decline. It is now 16.9.

The historical average P/E is around 16.5, suggesting there could be a bit more to give back.

Technically speaking, we haven’t even had a real fix yet.

A correction occurs when the stock market drops at least 10% from its previous high. The most popular stock indexes – the Dow, S&P 500 and Nasdaq – all hit record highs on Friday, January 26. On Tuesday morning, the Dow Jones briefly traded down 10% from that Jan. 26 high, but then rebounded and ended up closing well above a correction.

The S&P 500 and Nasdaq still haven’t reached correction territory, even temporarily.

“From a technical perspective, no, we haven’t reached that correction yet,” said David Lebovitz, global market strategist at JPMorgan Asset Management. But he argues that because 2017 was such a quiet year in the markets, what we just went through felt as a fix.

Invesco’s Hooper dubbed it a “lightning correction” because it happened so quickly.

We only had three days of sales. Since 1945, the typical length of a correction has been 71 trading days, or about 2.5 months, according to MarketWatch. The last correction started in the summer of 2015 and lasted about six months.

It is still possible that we will see the market close in correction later this week or this month.

“I think we’re closer to the end than the beginning, but now is not the time to make the most of it,” Lebovitz said.

Here’s what to watch for moving forward.

First, have the economic fundamentals changed? Overall, the US economy still appears to be in very good shape. Unemployment is low. Consumers and businesses are opening their wallets and spending. The economy is growing and inflation, which would have scared off investors, is still just 1.7% (below the Federal Reserve’s inflation target of 2%). The main concern is that the economy could overheat and the Federal Reserve could make a mistake and raise rates too quickly, but none of that has happened yet.

The market will be closely watching incoming data in the coming weeks, especially on wages and growth.

Second, have the fundamentals of the business changed? Companies are seeing very strong profits lately. Some companies like Amazon and Apple even had record quarters. Recent tax cuts are making businesses more profitable and boosting the confidence of many business owners. Overall, companies appear to be in great shape, but some stocks are still more expensive than others.

Investors will watch for stocks that gain or lose too much, like what happened in January.

Finally, watch for other “flash crashes”. The other factor to pay close attention to is whether there are more lightning-fast declines like what the market saw at 3 p.m. Monday when the Dow fell about 1,000 points in seconds. Most blame IT commerce for this rapid decline. Humans simply cannot trade that fast on their own.

It looks like a lot of these computer “technical trades” have been made, but they could easily reappear if the market starts falling rapidly later this week or month. Keep an eye on these moves. This is a sign that there are more factors at work than the “fundamentals”.

“These computerized sales models are written by people who don’t understand all the mechanics of the market,” said Anderson of MND Partners.