Market declines and volatility, is this normal?

Since the highs reached on September 20th, markets have experienced a correction, which is defined by a 10% drop.  This correction was the second in 2018 as markets fell 10% in early February.  So how normal are these drops in the market?

Although this recent volatility may have created some anxiety and brought out doomsday predictions, it is more normal than one might think.  Over the past few years investors have become accustomed to below average volatility and minimal market swings.  This recent bout of volatility is just ending a long period of low volatility by historical norms.

So, what is normal volatility?  Since 1980, the S&P 500’s average annual intra-year decline (high point to low point, at sometime within the calendar year) is 13.6%.  In the chart above (top of the page), the grey bars are the S&P 500 returns return for the calendar year, while the red dots are the largest intra-year decline the market experienced at some point during that year.

If we use 2012 as an example, while the S&P 500 dropped by 10% (red dot) at some time during the year, it did finish the year up 13% (gray bar). As you look further at the other intra-year declines going back to 1980, you will see they occur every year and double digit declines occurred 22 times during this 38 year period making it more the rule, than an exception.

If corrections and declines are normal, then should we be worried about this turning into a recession and a sustained stock market decline? Could this correction be the end of the 9-year bull market? 

The independent economists we follow believe it is likely that this correction, is just that, a correction. With economic fundamentals and corporate earnings continuing to be strong, they do not see this turning into a recession.

Economic fundamentals in the United States are still very strong with many of the indicators pointing to a healthy, growing economy.  Recently the Federal Reserve Chairman Jerome Powell (head of the United States banking system) said, the United States economy, has a “remarkably positive outlook” and forecasted economic data and figures are “not too good to be true”.  His strong words and are supported by positive economic data:

1. GDP growth for the last 2 quarters was 4.2% and 3.5%. This is strong growth compared to the average since 1997 of just 2.7%.

2. Consumer confidence levels are near all-time highs, which points to higher spending to spur on the economy

3. The incredibly low unemployment rate of 3.7%, combined with 7 million unfilled jobs in the US, characterizes how strong the US labor market is. Low unemployment creates more paychecks, which creates more spending to fuel a growing economy.

Corporate Earnings are booming, and these earnings are the prime driver of stock prices.   

2018 earnings growth is estimated and on pace to be 23% by the end of 2018, which is extraordinary when compared to the long-term average of 7.7%.

A question we get regularly is, “with corporate earnings and the economy booming, why isn’t the stock market skyrocketing?

The earnings growth in 2018 had already been priced into the market by the end of 2017, as stock prices rose dramatically at the end of 2017.  It is not unusual for markets to anticipate and prices to rise on that anticipated result. The primary reasons for the optimism at the end of 2017 were:

1. Strong corporate earnings estimates for 2018

2. The new tax law, creating economic stimulus

3. Reduced regulations enabling businesses to focus resources and attention on growth and expansion

So, if the economists believe the economy is still strong, expanding, and the recent correction in not an inflection point for the US economy, then what is ahead for 2019? 

While we do not have a crystal ball to predict the future, the independent economists we follow do not expect to see a recession in 2019.  Instead they see continued strong earnings growth of 9.4% (well above the long-term average of 7.7%) and if these estimates come to fruition, we could see a positive year for markets.

As always feel free to reach out to me with any questions,

Evan Werckenthien, CFP©

Evan@EWwealth.com

Work: 317-587-0858

Cell: 317-627-2529

References:

Factset, Standard & Poors. J.P. Morgan Asset Management

https://www.reuters.com/article/us-usa-fed-powell/powell-u-s-outlook-remarkably-positive-with-low-unemployment-tame-inflation-idUSKCN1MC2A7

https://www.factset.com/hubfs/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_111618.pdf

Professor Jeremy Siegel’s seminal Stocks for the Long Run, first published in 1994.

Yardeni Research, Inc. and Thomson Reuters I/B/E/S for actual and estimated operating earnings from 2015. Standard and Poor’s for actual operating earnings data through 2014.

Disclosure:

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Source: Experian, Federal Reserve