Investment Insights

 — Steve Orr 

At a Glance:

• Tariff whiplash trauma the trigger
• Typical correction not done
• Treasury rates rising
• Time not done 

Zoom out

This week “celebrates” the one month anniversary since the S&P 500’s last all-time high. That February 19 high is also eerily the same date as the index’s pre-shutdown high in 2019. The most recent Friday/Monday rallies were a welcome relief from the relentless drive lower. There were only nine up days in the last 20 for the major U.S. indices.

We are in correction territory for most of them, and the S&P 500 joined the “minus 10%” club on March 13. Is this the start of a new Bear? Is the market telegraphing recession? We think neither. There is definitely the smell of slowdown fear in the air. The hard data of actual transactions and hiring are more important than news trauma and noise. Uncertainty and weaker sentiment fueled the correction. Despite the Wall of Worry, what is ahead for the current correction? 

History lesson

No, not another boring history lesson. But a brief review of corrections should put the recent run into perspective. Humans, especially the trading sub-species, tend to do the same things over and over again. Most stock corrections follow a pattern: prices rise, making stocks overvalued. The trend loses steam, and prices wallow or try to breakout higher. Finally, some triggering event causes sentiment to change and worried traders start selling.

We think the big move for this correction is about done. Looking at the percent drop in the S&P 500 at just over 10%, and little more in the NASDAQ, it is a pretty typical correction. The median correction is a drop of 10.5%, so we are in the ballpark for washing out and bottoming.

Now, the speed of the move down is more impressive. The 10% drop over 17 sessions is the seventh fastest drop since 1929. President Trump owns three of the seven, in 2018, 2020 and this one. Last Thursday marked a sixth straight day of daily 1% gains or losses in the S&P 500. A run of six days with that much up and down volatility is pretty rare. These rare bouts of volatility usually need weeks of healing to settle down.

According to Bespoke Research, six and 12 months after a set of six volatile days, median returns for the S&P 500 are twice the historical average. There are several other historical points that suggest this is a garden variety correction for stocks.

First regular readers of our columns remember that this is year three of a Bull cycle. When the first two years are up more than 20%, year three struggles with one or more corrections and finally finishing the year positive.

Second, Bull cycles that reach the age of two generally make it to age five. Of the eight post-WWII Bulls lasting five years, all ran into turbulence and had a correction in month five of year three. Our current Bull started in October 2022, and here we are in month five of year three. Right on time. Like the run of six vol days mentioned above, if this Bull follows prior cycles, we are in for a few more bumpy weeks before price action settles out.

Corrections are driven by price, time or both. This past month the major stock indices have corrected in price. The best time corrections occur when stocks just grind sideways for months or years. Most corrections involve both — a price drop followed by grinding sideways or brief rallies as the market rebuilds internal strength. We vote for time corrections every time. 

Inflated

Enough of the market technicals. Last Friday’s and Monday’s rallies were more about position squaring ahead of this week’s Fed meeting and the quarterly expiration of options and futures at Friday’s close. “Soft data” surveys from the regional Fed banks suggest businesses are starting to sit on their hands. That is understandable given tax and tariff uncertainty.

Last fall we thought the new administration should renew the expiring lower tax rates, de-regulate and then cut the size of government. Two months on from inauguration, the order appears reversed. Lots of noise about cutting the size of government, which Congress will have to approve later and some action on oil drilling de-regulation. The tax bill waits in the wings, possibly Labor Day passage.

Tariff whipsaws and constant news noise affect consumer and business views of current conditions. Retail sales stats and volumes of big-ticket items suggest consumers are also sitting on their pocketbooks. Putting everything in the blender suggests the economy appears to be slowing earlier in the year than we anticipated.

Feelings and opinions on current uncertainty also affect views about the future. The University of Michigan’s most recent bi-monthly consumer sentiment polling showed sharp drops in sentiment and expectations for the economy in the coming months. The index that got the most attention from commentators was the jump in inflation expectations a year from now. Survey participants felt that inflation next year would jump from 4.3% to 4.9%. We would caution readers that this survey is skewed by political affiliation. Before the election the results were flipped, where the out-of-power party thought inflation would rise more than members of the other party. We are not buying the inflation jump thesis and expect inflation will rise only into the mid-3% range.