Since the stock market bottomed in 2009 it has skyrocketed nearly straight up making one new record high after another leading many to ask, “Does the market correction cometh”?
Historically speaking, the stock market experiences a correction (defined as a decline of 10 percent or more) about every two and a half years. Although the US stock market got off to a shaky start this year losing about 6 percent between late January and early February, the last time it experienced an actual correction was way back in 2011 when the market lost about 16 percent between July and October. So, an argument could certainly be made a correction is long overdue, right? Not so fast. What has been the longest period of time the market has gone without experiencing a correction? From 1990 to 1997 the market went over 1,700 trading days without a 10 percent or greater pullback, more than three times longer than the current run. There was another run beginning in 2003 that was longer than 1100 trading days. Based on this information I have determined a correction is likely to occur sometime between now and five(ish) years from now. Give or take a few months.
Although the experts will argue over when a correction will occur and how severe it will be when it gets here, I predict some of them will be correct and more will be wrong. Further, many of those that do get it right will more than likely make their prediction using the “broken clock is right twice a day strategy.” In case you are becoming sorry you even started reading this, hang in there and let me give you a few things that will hopefully help us beat the broken clocks market prognosticating results.
There are a few things I watch to help me determine the level of short term confidence I want to place in the stock market. They are Federal Reserve Action, yield curve, investor sentiment, and stock valuation.
As long as the Fed is in the mood to fuel the stock markets fire, I’m comfortable going along for the ride. The Federal Reserve uses short term interest rates called the Federal (Fed) Funds Rate to help stimulate a slowing economy by lowering interest rates or putting the brakes on an overheated economy by raising interest rates. The Fed Funds rate is the rate charged for banks to trade money with each other through the Federal Reserve. The theory being there will be more economic activity when money is cheap (low interest rates) and less activity when rates are higher. Since the last recession was so severe, the Federal Reserve took the extra and unusual step of trying to make money even cheaper by printing more of it and pouring it into the banking system using a program they called quantitative easing hoping to get more money flowing through the economy. Unfortunately or fortunately depending on who you talk to, the money didn’t flow into the economy as much as hoped instead getting trapped in the banking system primarily because of strict lending standards. Bad news, the economy is still sluggish. Good news, the economy is growing, but very slowly. So, although the Federal Reserve has cut back on quantitative easing, the new Fed Chief, Janet Yellen has indicated the Fed funds rate will remain low for a long time. This should be a positive environment for the stock market.
Secondly, keep an eye on what is called the yield curve. This is a way to compare short term interest rates vs. medium and long term rates. When short term rates are lower than long term rates, the yield curve is “upward sloping” which is good for the economy and by default, the stock market.
When they are about the same, the yield curve is said to be flat which is neutral and if long term rates are lower than short term rates the yield curve is inverted. Almost always an inverted yield curve is followed by a recession and recessions are bad for the stock market. Right now the yield curve has been flattening a bit but is still in a very healthy upward slope!
Sometimes watching your fellow investors actions can help determine short term market movements. I am typically more comfortable with the stock market when there is a high level of investor skepticism and get nervous when people start laughing in the face of risk. This “signal” is a little mixed for me right now. There are still a lot of people very afraid to invest in the stock market and they remain on the sideline waiting for a big correction and they have a lot of cash to spend. On the other hand, investors currently “in” the market seem to me to be increasingly and without concern, taking risks.
The last thing I look at is stock valuation. Again this is currently kind of mixed and I would say the overall U.S. stock market is fairly valued by historic standards but not cheap. However, with a little digging there are plenty of good individual stock values out there.
So although I don’t see any significant signs of an imminent market correction, one never knows. Many analysts expect the market to be a little more volatile this year and probably post mid to high single digits return. I and the broken clock concur.
(Editor’s Note: Chad Winn is a financial advisor for Wells Fargo Advisors. He can be reached at 584-3017.)