The S&P 500 fell a little over 5% last week, is down 10.1% peak-to-trough and 2% for 2018. The index hit it’s 200-day moving average on an intraday basis Friday and bounced. This average should act as support in the coming weeks.
While these type of corrections are never fun to experience, a 10% correction given the strength we have seen in global markets recently is normal. The S&P 500 is in a short-term correction within a longer-term uptrend.
The reason given by some analyst for the drop in the stock market is the strong rise in interest rates/bond yields. The problem with this rational is that historically rising yields have been positive for stocks.
Below I have charted the 10-year yield going all the way back to 2000 in the upper panel and the S&P 500 in the lower pane. I have highlighted the periods of rising yields in green and during those periods the market has typically advanced strongly.
The advance-decline line is a longer-term breadth indicator and has been pretty accurate in signaling major stock market corrections, like the one that occurred at the end of 2015 when the average crossed below its 50-day moving average. While the average has declined with the market, it did not display any negative divergences prior to the market top and it has not crossed below it’s moving average.
If the drop in stocks had been preceded by a deterioration in market breadth and price action had not been so strong, I would be worried. Globally stocks have been hitting all-time highs, risk-on assets have been outperforming defensive assets, market breadth has been positive and a rising yield environment is historically positive for stocks. In addition, a 10% correction in a bull market is completely normal and expected given the run we have had.
On a short-term basis, the stock market is oversold. The S&P 500 did bounce on it’s 200-day moving average. So going forward I will be watching to see how strong of a bounce we get and if the market can hold above that important average.
First and foremost, I am a risk manager and thus I will continue to monitor market conditions. If conditions deteriorate, I will get more defensive; however, I believe the weight of the evidence is still bullish for stock in the longer-term.
The Bottom Line
Positive for Stocks and Commodity Prices
Negative for Interest Rate Sensitive Bonds
• The stock market is in a short-term correction within a longer-term bull market.
• The stock market is oversold on a short-term basis and due for a bounce. The strength of that bounce should provide clues to the longer-term strength of the market.
• Long-term, the weight of the evidence continues to be bullish for stocks. At some point, this will change and when it does, I will have no problem flipping to a bearish bias and reallocating client accounts to a more defensive posture. However, market technicals continue to signal that we are in a bull market and thus we should be invested in stocks aggressively.
I continue to view stock market risk as low, thus our accounts have high stock market exposure.
I have continued to add to our equity holdings by buying stock funds that have pulled back and are in long-term up-trends.
We do not hold any interest rate sensitive bond funds.
Craig Thompson, ChFC
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We are an “active” money manager that looks to generate steady long-term returns, while protecting clients from large losses during major market corrections.
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