By: Jeff Pollock
February 12
, 2018

This month’s pullback in stock prices has been called everything from the end of the bull market to a healthy and long overdue correction.

Going back to the early 1950s, market corrections – a drop in values by at least 10% from their previous peak – occur about every 19 months and the average decline has been 13.4%. Last week, the S&P 500 pulled back by 10.2%, its first correction in 24 months. Since then, it’s bounced back and now trades 7.6% off the recent highs achieved January 26.

Several observations from last week are worth noting.

First, the correction was initiated by a rise in the yield on 10-year US Treasuries. This was said to be caused by fears of rising inflation following January’s +2.9% hike in average hourly earnings for US employees. However, inflation-linked assets (such as commodities) didn’t avoid the selloff. Commodities perform well in an inflationary environment. According to Bloomberg, energy and copper increased 28% and 17%, respectively, for everyone 1% annual increase in the CPI since 1991. However, energy and copper participated in last weeks selloff. Furthermore, inflation expectations – the spread between yields on nominal and inflation-linked U.S. Treasury debt – also contracted last week. In other words, the market may suggest that inflationary pressures are right now merely transitory.

Second, the media took interest in the number of points that the Dow Jones Industrial Average contracted by during the week. One decade ago, a 1000-point drop on the 10,000-point Dow would have represented a 10% decline. At last week’s 26,000 level, a 1000-point change no longer represents the same material impact it once did from a percentage perspective.

Third, the market has now experienced 40 corrections in total since 1950. In other words, 39 full recoveries have followed. We expect there to be a 40th recovery as market corrections always prove to be temporary in nature for the long-term investor. However, we do not expect to read anything on the front page when the recovery is complete because the newspapers prefer to emphasize negative stories instead.

Fourth, the S&P 500 appreciated by 5.9% between December 29, 2017, and January 26, 2018. It is fair to say that with a lack of volatility, complacency may have set in for many investors at the start of the year.

Overall, we believe last week’s selloff was a correction and not the end of the bull market. Corporate profits are growing at double digits, the economic data continues to show encouraging trends, and bonds as an asset class offer such dismal returns that investor appetite is tepid at best.


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