Weekly Update

Uncertainty in the Market

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Published May 14, 2021


The stock market continues to hold on through intermittent bouts of selling. Corporate earnings have been record-setting in their growth from year-ago levels, severely depressed though they were. Despite outrageously good earnings for the top growth stocks in the Nasdaq, investors continue to shift money to cyclical value sectors like energy, finance, materials. The lackluster response to the hotshot earnings has led to some heavy down days in the market recently. Below is a quick review of market drawdowns from our friends at DIM.

“During the Covid recession of 2020, the S&P 500 declined by about 34% in three weeks. Five months later in August 2020, it had returned to its February 2020 high. Over the next eleven months, the S&P 500 climbed another 25% higher.

The market moves fast. Significant drawdowns can swiftly strike the market. Recovery can also happen surprising fast as long as the economy is not headed for a recession.

Below is a chart showing the number of declines in the S&P 500 by percent decline, length of the decline and length of the stock price recovery from 1950 through today.

Number of declines in the S&P 500 by percent decline, length of the decline and length of the stock price recovery from 1950 through today

Since 1950, the S&P 500 has suffered 43 pullbacks of 5-10%. In terms of time to recovery, 5-10% fluctuations in the market are relatively inconsequential as the average time to recovery is one month.

Assuming we view stock market investing as a multi-year endeavor, the only line in the chart above that is concerning are the three instances of 40+% drawdowns when the decline and the recovery totaled almost five years.

These three cases of 40+% declines were 1973/74, 2000/02 and 2008/09. All three were associated with major recessions. Since World War 2, we have not experienced a major, multi-year bear market without the occurrence of a recession.

When the stock market begins to pull back, one of the first questions an investor may want to ask is are we headed for a recession. Again, without a recession, downside market volatility is relatively brief.

Two of the most robust predictors of the recession are the U.S. treasury yield curve and the Leading Economic Index (LEI). When the yield curve is inverted and when the six-month moving average of the LEI is negative, it is likely a recession is on the horizon. Otherwise, the coast should be clear. Today, the yield curve and LEI indicate the probability of recession in the next six months is low.”

U.S. treasury yield curve and the Leading Economic Index (LEI)

Stock price volatility can cause investors to make emotional buy/sell decisions. Given the speed at which the stock market can move, it helps to use robust, time-tested measures to help remove the emotional component of stock market investing in the heat of the moment. Many expect the market to continue being choppy as the strong uptrend from last November gets digested and a new wall of worry is built. Emotions can lead us astray during these volatile periods. Our models provide the unemotional guidance for our investment decisions.

Market Update

Tech/Consumer stocks continued to be a struggling area of the market. Monday brought a -2.5% drop in the Nasdaq while the Dow Industrial average closed flat. The Dow Industrial average is less weighted toward tech/consumer stocks and more toward industrial/cyclical stocks. Higher interest rates have led to selling in high-growth tech/consumer stocks. A wild day Tuesday saw stocks broadly down -2% before tech/consumer stocks caught a bid and recovered to close almost flat. This day was a reverse of Monday as Dow Industrial stocks did not rebound, ending the day down -1.6%. Inflation reports are coming in very hot as they are comparing to depressed year-ago levels. Sharp price rises in all commodities helps fuel the jump. Investors are nervous about inflation, worrying that rising prices will push the Fed off their ultra-easy monetary stance. Another inflation report Wednesday led to more selling. All indexes tumbled more than -2% on the day with growth stocks once again suffering more. Stocks got a bounce Thursday as buyers came in to buy the lower prices. Several Fed officials reaffirmed the group’s view that inflation will be temporary as the economy restarts. Yields dropped back a bit on the comments. Yields fell again Friday leading to another move back upward in stocks. Market averages posted solid gains though the bounce was not enough to overcome the selling earlier in the week.

For the week the S&P 500 (SPY) slipped -1.63% while the Nasdaq 100 (QQQ) fell -2.76%. Smallcap stocks (IWM) gave up a key moving average in falling -2.68%.

Warm wishes and until next week.