A Time to Look Forward

Correction or bear? That is the question on most investors’ minds this week, with Wednesday’s 5.0% S&P 500 rise doing little to quell the speculation.^[i] Headlines continued fixating on stocks’ distance from the -20% marker, wondering if a bear market is “coming”—the implication being that it will have arrived if and when we reach that threshold. We can’t help but see a grand irony here: A bear market doesn’t begin the moment stocks cross -20%. If major indexes do breach -20% and stay there for any length of time and society broadly agrees it was a bear market, then history likely treats it as a US bear market that began on September 20—the S&P 500’s most recent peak—or a global bear market that started in late January. While this might seem pedantic, we think it is important for investors to keep in mind. Treating -20% as meaningful implies there is something investors can and should do once stocks get there. Yet that would amount to reacting to past volatility. So rather than looking back and labeling what already happened, we think it is important to look forward, consider what is likeliest to happen from here, and make sure you are positioned for it. 

On his Twitter account Friday, Fisher Investments’ founder and Executive Chairman Ken Fisher offered the world this pearl of wisdom:

The difference between a max 19% correction and a mini-23% bear market is a distinction without a true significance. The key is whether we get a full fledged bear with a global recession. Without that from here the right thing to do is the same regardless.

The reason this distinction isn’t meaningful? By the time you make the determination—correction or bear—you would be long into it. Too late to do anything about it. You can’t block a punch you have already taken. You can’t go back in time and reposition. You can only position for the future.

So the question to ask now isn’t, is this a correction or a bear market? Rather: What do stocks do from here? Not overly specific and short-term questions, like whether Wednesday was a false start in a correction’s recovery, a bear market rally preceding something much worse or the start of an actual rebound. Think bigger picture: Are stocks likelier to be in the early stages of a mess on par with 2000 – 2002 and 2007 – 2009, or are we nearing the end of something much shorter and shallower?

As we survey the fundamental landscape, we see a lot of evidence sentiment has overshot the economic and political reality. Major yield curves aren’t inverted. The Conference Board’s Leading Economic Indexes (LEI) for the US and eurozone remain in long uptrends. If a US recession were starting now, it would defy a nearly 60-year history of no recessions starting while LEI is high and rising. The forward-looking new orders components of most nations’ purchasing managers’ indexes (PMIs) remain in expansionary territory. China, though slowing, is growing. So is world trade, despite this year’s new tariffs. Meanwhile, headlines look, sound and feel a lot like they did in February 2016, October 2011 and even March 2009. All news is bad news. Colorful verbs like plunge are everywhere. So are urgent-sounding adjectives and worst-since-yada comparisons. This, coupled with this month’s sharp mutual fund outflows and other indications of investors racing for the exits, seems a lot like sentiment nearing extreme levels typical of market lows.

There are variables that could cause deep economic problems from here, and we are attuned to the risk. But none of these seem to be in the offing now, to us. For example, Chinese policymakers could botch stimulus, or their prior actions to curb runaway lending in the shadow banking sector could prevent money flowing where it is most needed. The Fed and/or other major central banks could blunder, perhaps by restarting quantitative easing as a reaction to this volatility—tugging down long rates and inverting the yield curve. The Brits could call a second Brexit referendum, vaporizing the chance for uncertainty to fall there in the near term. But one thing these (and other potentially negative) events have in common is that you can’t predict or plan for them in advance. They aren’t market functions. If you get out of stocks while waiting for a massive Fed error that doesn’t come—or comes three years from now—then you have locked the drop in and probably missed your chance to recover in the near term. Therefore, as uncomfortable as it might be, we still think the right move—a critically important move—for investors who need market-like returns over time is to stay in the market. If any of these bad things happen, setting up a high likelihood of much more downside ahead, there should be time to consider them thoughtfully and make more measured moves when the time comes. It needn’t be a split-second decision.

Instead of dwelling on potential worst-case scenarios, however, we encourage you to head on over to Ken’s Twitter feed and read through the last week’s worth of posts. There you will find his thoughts on what is contributing to this month’s volatility—as well as some compelling reasons to anticipate the V-shaped bounce that usually follows steep routs like this. We will leave you with a preview as we part:

Note in the last few days how much more some commenters here see bad things ahead they didn’t vigorously cite before…or cite at all. The vehemence rises with the decline. That is normal. Normalcy with a steep decline having increasing pessimism is classically bullish.