The stock market is taking a breather this past week and as of the market close on Wednesday, the S&P 500 is down -4.95% since the most recent high, while the Dow has followed in suit, down -4.58% over the same time period.  When we’ve observed pullbacks like this in the past, we normally see the money flowing out of stocks (which causes the pullback) and into bonds, which then drives up the value of the bond market.  This time, things are different.  The bond market is actually down -4.50% year-to-date and all of this is making the pain felt on portfolios worse than in a “normal” pullback.

Let’s get back to the stock market. 

First, here’s what people are freaking out about right now (just in time for Halloween):

Essentially, what you’re looking at, above, is a mere -5% pullback in the S&P500.  What you may not know is that pullbacks happen regularly.  A “pullback” is defined as a -3-5% drop in the market and it happens about 3 times per year.

This becomes a whole lot easier to observe when you take a look at a longer-term chart.  Viewing the chart below, this most recent pullback doesn’t seem so scary now, does it?  When you look closer, you will notice that momentum (lower pane) became more oversold (lower) yesterday (Oct 10th) than it’s been since 2015.

However, before jumping off your balcony, let’s add some additional perspective to the chart above.  When the market was dropping in 2015 (and again in 2016, mind you), it dropped more than -10%, into correction territory, twice, all within the context of a long-term downtrend, and coupled with weakening breadth (i.e. – Participation, when more stocks were crashing and far fewer were participating in the upside).  Look at the pullback we’re experiencing this past couple weeks… sure, momentum dropped, but all within the context of a long-term uptrend.

Here’s some additional perspective, below.  What you’re looking at is the annual returns of the stock market (bars) and below each bar, you can see the lowest market pullback or correction that occurred in each of those years.  Remember that I mentioned earlier that we typically see a drop of -3-5% three times per year?  Well, we also tend to see an annual correction to the tune of -11% per year, on average.

To elaborate, drops of -3%, -5%, -10%, or even -15% are completely healthy!  Not to mention, they’re not all that difficult to recover from.  It’s “the big ones” we’re trying to avoid…. Market crashes to the tune of -30%, -40%, -50% and more.

But WHY is the market selling off so much this past couple weeks?  I personally believe that the trend is all that matters.  If it’s up, I want to be in the market and fully invested in high-growth/momentum investments.  If the trend is down, I want to be extremely selective with what I buy, that is, if I’m buying any stock-related investments at all.  And when the trend is flat, I want to be cautious, raise the trapeze nets on my exit strategy, and prepare for a longer-term directional change.  Flat markets are the toughest, in my opinion, but my point is, I don’t really worry too much about the news.  I care more about the trend, and you should too!

But if you MUST know, the markets sold off these past couple weeks for a number of reasons:

  • Trade war worries,
  • Concerns about the upcoming earnings season and whether stocks will meet expectations,
  • Italian government budget drama,
  • The recent spike in interest rates, and
  • Profit taking by shorter-term traders.

You probably weren’t even aware of half of the “reasons,” above, but the point is, there’s never a shortage of political or economic news to worry about.  Never!  So you have to know your timeframe (long-term, right?!), and you have to keep these short-term drops in perspective.

Below, you can see the survey of speculators (dumb money) vs. commercial hedgers (smart money).  When the red line is high and the blue line is low, risk levels are high and there’s a higher chance for a short-term pullback or correction.  When the opposite is true – when the speculators are freaking out and running for the exits – that’s usually a good thing for the markets, as the “dumb money” tends to do the wrong thing, almost all the time.  Right now, we’re at equilibrium, which is fine with me.  In other words, risk is relatively muted at this juncture.

Here’s a great chart from my friends at The Stock Trader’s Almanac.  Again, more evidence that this recent, healthy breather in the market is just that – healthy!  Notice how the first seven trading days of October are normally down (and remember, it’s trading days, not calendar days).

I mentioned earlier that the bond market is struggling.  Again, down roughly -4.50% as of Wednesday’s close, all this supposed “safe money” is getting beat up.  Moderate, balanced, and conservative portfolios are being dragged down by what normally is a low-volatility hedge against market declines.  Instead, it’s actually performing worse than the stock market.

But think about this for a minute… when investors sell their bonds, where do they put that money?  It could be they put it in the bank.  But it’s also highly possible that they reinvest it into U.S. stocks, international stocks, or commodities.  Maybe currencies, such as the U.S. Dollar, which has been very strong as of late…

…or gold, which based on what I’m seeing, could be bottoming here.  I like the “floor” of support at $1,185 and while I’m not a buyer today (I don’t like to guess… I like to follow the trend, not predict it!), depending on whether money flows out of bonds, what the U.S. Dollar does, and where the proceeds flow, we could see prices in gold, miners, and other precious metals start to rise.  I’m still neutral today, however.

One of my new analogies I find myself repeating a lot lately is, “Focus on the horizon, not your feet.”  In other words, focus on the longer timeframe and ignore the short-term noise.  Turn off the news and go outside.  If it’s too cold or rainy, watch a movie or go out to eat.  Build a playlist, turn off your news radio (yes, even the political news), and listen to some music.  Sing along!

If you visit our website at www.LibertasWelath.com and go back to mid-2015 through 2016, you’ll quickly learn that I’m not of these portfolio managers that always preaches that the market is going up (or down, for that matter).  In our business, we call these people “Perma-Bears” or “Perma-Bulls.”

Markets take months (roughly 18 months, on average) to crash, but I can’t believe I’m even bringing up that stat because I can objectively tell you that at this moment, observing all the indicators and analysis I comb through on a daily basis, that there is much more evidence that this market is heading higher.

If you’re freaking out and want someone to talk to, aside from cars, Buckeye and Browns football, there’s nothing more I like to discuss than the markets.  So, feel free to reach out!

Till next time…

Adam

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* Adam Koos, CFP® is a CERTIFIED FINANCIAL PLANNERTM  Professional, as well as president and portfolio manager at Libertas Wealth Management Group, Inc., a Fee-Only Registered Investment Advisory (RIA) firm, located in Columbus, Ohio.

 The opinions mentioned in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser and strongly consider interviewing a fee-only financial advisory firm, prior to investing. Past performance is not guarantee of future results. Economic forecasts set forth may not develop as predicted. The views and opinions expressed in this commentary are those of Adam D. Koos, CFP® and do not represent the views of TD Ameritrade Institutional and its affiliates. Investing involves risk including loss of principal.