The S&P500 fell -4.1% yesterday, which capped off a 6-day pullback that ended in a total drawdown of -7.8%. Looking at where the market sits today, the price is roughly the same as it was on December 8th (or roughly eight weeks ago).
As I write this week’s commentary, the market is down another -2.83% in after-hours trading (at 11:42pm on Monday, February 6th).
Until this past week, we hadn’t seen more than a blip of downside pressure in well over a year, but for the first time since election day (a full 15 months ago) we’ve finally experienced an official pullback and perhaps a market correction.
If you or anyone you know are freaking out, it’s important to understand what makes this past week’s pullback seem more painful than usual. When the market goes up so far, for so long, without any sort of reprieve – which I reiterate, is healthy – it’s likely going to feel worse than it is. Ever tried sitting in a hot tub for 15 minutes and then immediately jumping in the pool? Seems colder than it is, doesn’t it? In this analogy, the stock market was the bubbling hot tub and the pool is the natural cooling-off cycle that the market experiences in any “normal” year.
Analysts are blaming everything from the rise in interest rates and profit-taking to the sanctions slapped on Wells Fargo. I have my own opinion with regard to “why” the market is correcting, but I personally don’t think the “why” matters at all. The only thing “why” does is give us something to talk about when the event du jour is already over with. In the end, the question remains, “Is the trend still up, or is it not?”
So, what should we do today? Panic? No… at least for now. What we saw this past week is market action that doesn’t happen often in an investor’s lifetime. However, just like I wrote about how the market was horribly overheated and due for a situation just like this one, now it’s at a point of being extremely oversold and “on sale.” Most importantly, the long-term trend is still positively intact, so weakness such as this should be used as an opportunity to buy when prices are on sale.
Sentiment Trader reported that there have been three times in history where we’ve seen similar situations take place. Here are all three, below:
1965: The market rises for 370 days without a 5% pullback, which was then followed by a quick drop of -9.6%, but followed by a +15.2% rise over the next six months.
1994: The market rises for another 370 days without a 5% pullback, drops -8.9% with a quickness, but finds its footing within a matter of four months before climbing +54.6% northward.
1996: The market rises for another 370 days without a 5% pullback, falls -7.7%, and then finds itself +30.2% higher over the next seven months.
The average drop in the prior events above was -8.73%. As mentioned above, Monday’s market close puts us at -7.8%, so we could see additional downside movement before we see a near-term bottom.
What are the odds the market is UP six months from now? Volatility (as measured by the VIX – or Volatility Index) experienced the second-biggest spike in its 32-year history, climbing 112% yesterday, alone! Jason Goepfert of Sentiment Trader pointed out that, whenever the VIX climbs 50% or more in a day, the market has been higher 1, 2, 3, and 6-months later, 100% of the time. Naturally, this could be the first time we see lower prices six months from now, but I feel this is a pretty good risk vs. reward scenario.
Let’s go another step further… There have only been 12 times in history when the market has dropped -6% within 6 days of hitting a 52-week high. Of the 12, there was only one occurrence (1938) when the market was down still 2 months later, and only three occurrences (1938, 1979, and 2007) when the market was down six months later. The average performance of the S&P 500 was actually +9.8% at the end of that six month period.
As I was doing my research this evening, I found it incredibly interesting that Fidelity reported 52% more buying than selling on Monday, which is not the kind of price action one would expect when the market is on fragile ground. To the contrary, Robo-Advisory firms Wealthfront and Betterment both experienced outages, which could’ve been due to individual investors wearing out the “sell button.”
Lastly, my good friends at Optuma helped me put together a chart that plots the Dow today on top of the 1987 – 2000 bull market, which was the longest in history. Speaking of history, while it doesn’t necessary repeat itself, one of my mentors always use to tell me that “it sure does rhyme.”
So with all that being said, risk levels are MUCH lower today than they were just a week ago. I wrote about the record-breaking momentum that was throwing up warning signs on January 16th and then again wrote about the overheating market on the 26th. Since I never know where the top or the bottom is, I use a systematic process and a multi-faceted buy-side strategy for getting into the markets. This approach got us invested in three separate waves between Tuesday’s shallow dip (last week) and yesterday’s metaphorical clearance sale.
Sometimes it’s painful to be in the market. Other times it can feel even more painful if you have what seems to be too much money on the sidelines. In the end, it’s going to be crucial to have a defensive strategy in place as this bull market continues to get more mature.
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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.