Asset classes are springing leaks at a rapid rate in the 4th quarter of 2018. In particular, global stock markets suddenly cast aside their complacency and sold off sharply with cascading events Oct. 10-11. Major U.S. indexes were down approximately -5.0% over those two days. The selling pushed markets below levels that have provided support in the past — the 200-day moving average.

Only two weeks into the quarter, almost all asset classes are down:

Source: Bloomberg L.P. — Prepared by Cardan Capital Partners

Stock markets seem to have been jolted awake by a heady cocktail of worries:

  • Continued fears surrounding trade
  • Rising rates
  • Global growth weakening
  • Mid-term elections
  • Oil prices
  • Chinese Yuan depreciation
  • Upcoming earnings

This type of price action inevitably brings out bearish commentary from all corners. As we see the world today, we do not believe this is the beginning of the end, but, instead, a standard correction within a bull market. The truth is that no one knows exactly what caused the pullback — but we will try to provide some perspective.

The financial markets are made up of millions of people who are trying to gauge the activities and interactions of the billions of people who make up the global economy, buying and selling goods and services each moment of the day, making the economy grow or contract. If the millions of people in the financial markets are correctly sniffing out that the billions are slowing their rate of consumption and causing an economic contraction, it will start to show in the data. If warranted, we would change our course of action accordingly. However, as American Nobel laureate Paul A. Samuelson was famously quoted, “The stock market has called nine of the last five recessions.” Nothing in the data currently suggests a slowing in the economy, but we remain on watch. A historical perspective on market volatility is also helpful:

Historical S&P 500 Declines*

  • About 37% of S&P 500 quarters have had a negative return, averaging about -7%.
  • On average, the market drops -2% in a day, five to seven times a year, and -3% in a day two to three times a year.
  • About every five years, the market suffers a -20% or greater pullback.

Now the Good News*

  • The S&P 500 has advanced in about 74% of all calendar years (3/4 years).
  • The average total return for those annual positive years is about +21%.
  • The average total return for all years (92 years since 1926) is +12%, significantly outpacing inflation.
*Sources: Ibbotson Associates and Bloomberg L.P.

Since March 2009, during this current bull market, the S&P 500 Index has experienced 20 days of -3% or worse performance.

Source: Bloomberg L.P. – Prepared by Cardan Capital Partners

At this point, none of the -3% down days have been the end of the current bull market. So, what should we make of this current volatility? Is the 20th down day of -3.0% the straw that finally breaks the bull’s back?

The data would suggest that the billions of consumers are still buying and selling goods and services at a reasonable rate — which does not suggest a current economic contraction. The orange on the chart below marks the last seven recessionary periods in the United States as dated by the National Bureau of Economic Research (NBER). The blue line is a combination of the Conference Board U.S. Leading Economic Indicators, the U.S. unemployment rate, Industrial Production and the Chemicals Activity Barometer. Historically, this indicator crossing below zero has proceeded economic weakness. Currently, the signal sits above zero.

Source: Bloomberg L.P. – Prepared by Cardan Capital Partners

The data can change rapidly, and we are always monitoring to assess whether a change in the course of action is reasonable. The volatility investors are experiencing also may be a reflection of the market in transition, possibly foreshadowing the ending of the almost seven-year dominance of growth stocks over value stocks. Additionally, markets are now transitioning to an environment in which central banks globally withdraw liquidity in an effort to normalize monetary policy. For now, the fundamentals and economic backdrop appear to support stocks, but increased volatility can be the markets searching for a new equilibrium.

As a portfolio manager for more than two decades, I have participated in at least 78 down days of -3.0% or worse in the S&P 500, and at least 18 down quarters of -7.0% or worse in the NASDAQ. The bad news is facing them never get easier — but the good news is I no longer remember the majority of them. Market declines – market cycles – are a fact of investing, and I can guarantee they will happen in the future. I do not know when the next will arrive, but I do know it will be uncomfortable when it does. However, like a snake shedding its old skin (scientifically called ecdysis, commonly known as molting, done in part to allow the snake to continue to grow), new cycles breathe renewed vigor into the markets so stocks can once again proceed along their path of growth.

 

Disclosures: Any reproduction or distribution of this presentation, as a whole or in part, or the disclosure of the contents hereof, without the prior consent of Cardan Capital Partners, LLC, is prohibited. Certain information herein has been obtained from third party sources and, although believed to be reliable, has not been independently verified and its accuracy or completeness cannot be guaranteed. No representation is made with respect to the accuracy, completeness or timeliness of this document. Investments in securities entail risk and are not suitable for all investors. This is not a recommendation nor an offer to sell (or solicitation of an offer to buy) securities in the United States or in any other jurisdiction.