The Glass Is More Than Half Full

 In Strategy Updates

From our view the recent weakness and today’s continued selloff is a long overdue correction in a bull market.  Last week’s strategy update “Stranger Things” detailed some of our thoughts about the possibility of upcoming volatility and it couldn’t have been better timed. Why do we see this as a correction and not something worse? The answer relates to data, valuation metrics and, to some degree, the recent action of stocks during the month of January.

From a raw data perspective, economic and corporate profit data do not suggest that this is the beginning of something worse or a bear market. In fact this data suggests just the opposite: this quarter alone 85% of earnings reports have been better than expected – an extraordinary number and a sign of strong upward momentum. Recent data about global and domestic economic growth also suggest that the “glass is more than half full.” US GDP growth is nudging close to 3% while global economic growth was recently released at 3.6% – neither of which have been this strong in more than 10 years!  Investors should recall that the greatest risk to stock prices is an economic recession and on that front we see little risk in 2018. Lastly the market was not overvalued two weeks ago at the top and is even more attractive at today’s prices.

If anything is to blame for the recent pullback of stock prices as of late, it may be the stratospheric rise that stocks experienced for the three weeks prior: it was a trajectory that was abnormal and unlikely to last, hence last week’s Update. These types of short term dramatic upside movements have historically unwound in a similar fashion to what we are now witnessing. Easy come, easy go.  Ultimately, a healthy bull market corrects hyperbolic movements – up or down – quickly and this one was spot on.

Keep in mind that a normal stock market correction within a bull market is usually about 8-10% and as of today we have reached 10% from the high reached a week ago (although the points on the DJIA make it seem much worse, it isn’t).  Investors should prepare for the possibility of further declines, but we would suggest that quite a bit of the necessary selling is now behind us.  The market is now very oversold, which is a signal that a very real and lasting rally upward should be coming soon. At some point in the coming days and weeks, the market will find stability and begin once again trading on the very good news that exists in regard to economic growth and corporate profits.  We expect this year to be a good one for stocks, with normal corrections along the way.

If are wrong in our assessment of market fundamentals, and the economy and corporate earnings take a turn for the worse, we are prepared to reduce stock exposure and have stop loss orders in place to fend off and mitigate catastrophic loss.  At this point we do not think investors should do anything except look for great companies to add to their portfolio on this weakness – which is what we are doing as of this writing.

We hope these thoughts are helpful. If you would like to discuss further or if you have experienced a significant change in your financial circumstances, feel free to give us a call. As always, if you have any friends or colleagues who you feel may benefit from our services, we would be happy to introduce ourselves to them with a no-obligation introductory meeting.

Your Team at Main Street Research