The market had gone roughly four years without a correction defined as a pullback of at least 10% from the highs. Market pundits had been anticipating it for a very long time as the market continued to press on. The bull market had sustained itself even in an environment with an avalanche of things to be concerned about globally. There was Greece, would they exit the Euro, China, how weak is their economy, Russia, Iran talks, Puerto Rico, NYSE trading glitches and, the uncertainty created by the Fed’s decisions on interest rates. All things considered, the U.S. market and economy continue to lead.
After stellar performance in 2013 and above average returns in 2014, the struggle for the market this year has not been a surprise. The year began with an increased level of volatility and then we went into a narrow sideways chart pattern. From early February through early August the full range of the market was only about 4%. Technical analysis suggest that the longer the sideways pattern, the bigger the move up or down once the market breaks out of the range. During the week of August 17th the market broke the range bound pattern to the downside culminating with the disastrous opening on Monday August 24th. Corrections are typically quick and vicious and this one fit the mold. The opening for the NASDAQ 100 index was the worst gap opening to the downside in the history of the index down 8.34% at the opening.
So was this a correction or the beginning of something more sinister? We strongly believe this was a normal corrective backing and filling process in the context of a bull market that will potentially last several more years. Corrections are a normal process within a bull market and on average take place about every eighteen months. Since 1900, the market has fully recovered from a correction within about 10 months. Most corrections do not become bear markets and every single one of them historically has been a great buying opportunity in hindsight. Thus a reminder not to make emotional decisions or let the natural aversion to loss cloud judgement.
The basic fundamentals remain sound. Earnings are still growing and are reasonably valued, interest rates remain low and there is plenty of liquidity. The U.S. Economy is growing slowly but, there are significant signs that it is picking up some momentum despite apparent global weakness. In fact, the very reason the Fed is considering a rate hike is because our economy is showing underlying strength. The Fed will move to raise rates sooner or later, however, that will not derail the market. Since the 1950’s, the market has gone higher for an average of two and a half years after the first rate hike and has averaged a 9.5% return the first year following the move to tighten.
The bulls may be back. The market tested the lows on September 29th getting within five S&P500 points of the August low. The successful re-test of the low was followed by the best intraday reversal in nearly four years on Friday October 2nd. This action plus the follow through buying since is evidence of improving market conditions. The volatility index back below twenty may also be the all clear signal.
Though the short term is harder to predict, we remain bullish intermediate to longer term and expect the market has the potential to be much higher by year end.
As always, thank you for your trust and confidence.
