The Fifth Correction

“Good investors gather information, put that information into current and historical context, then make sound decisions.”

We are now firmly in the grasp of the fifth stock market correction of 2018. The Russell 3000 Index declined by -7.4% in just one week after that unsuspecting close of 1,729 on October 3rd. I say ‘firmly in the grasp’ because at this writing, after a +3.7% bounce off the initial low of 1601, the Russell 3000 Index is in the process of testing that low. My numbers reference the Russell 3000 Index because it includes 100 times more companies than the Dow Jones Industrial Average Index and 6 times more companies than the S&P 500 Index. In short, it gives us a much better view of the bigger picture.

The first correction of 2018 occurred in February. Like our current correction it hit bottom in just one week. The drop was significantly lower, measuring -11.7%, and the first bounce was much higher, up +9.9%. We experienced the second correction in March, with the Russell 3000 Index declining -8.6%, this time in just two weeks. The first bounce was +6.3% and took two weeks, only to immediately pull back into the third correction of the year. That decline of -4.4% also took two weeks but fully recovered in just one week. That recovery also broke a short-term downtrend and helped set up the five months of higher stock markets. Even then, there was a minor correction of -3.5% in June, once again with a two week decline and a one week recovery. That’s a lot of history and numbers in just two paragraphs, but the point is that corrections are part of investing, both in Bull and in Bear markets.

Corrections can be sparked by news, or by nothing at all. In the case of the fifth correction, it was mostly nothing at all. The chairman of the Federal Reserve was speaking at a conference the night before, with a positive reflection of the economy on his lips. He was the original suspect, but it was hard to find anything in his remarks that wasn’t already common knowledge. So it reverts back to the market’s equivalent of ‘clear air turbulence.’ Our coffee had just been served, with several sector breakouts to new highs, so most of it ended up in our laps. It was surprising and made a mess. Now we are working with the clean-up.

I am reminded how quickly things can change when I am in the pasture with my horses. If I get in tight and start working cockleburs from their manes it’s easy to lose sight of their collective hips and heads and hooves. These are the very areas that my grandchildren are taught early to always be aware of so they are safe. It’s much wiser to save the cockleburs for the barn and instead enjoy how the herd moves together, interacts, and maintains their order. Horses are far more predictable than stocks. I just wish they were profitable.

As unpredictable as the short-term can be, intermediate-term and long-term trends are much more manageable and profitable. The keys to success are having sensible rules in place and keeping a cool head. The first part can be pretty easy. The second part can be difficult. Sometimes it comes down to keeping your distance. If you get too close to the action, you can lose perspective. If you stand too far away, you can miss important signals that help you recognize shifts in direction and accompanying opportunities.

When you step back from this correction, one of the most important things to recognize is that we are rapidly approaching what has historically been the most profitable season for equities. November, December, and January have been the most productive contiguous months for equities since 1950. They are right around the corner. Then you have to acknowledge that the U.S. economy is the strongest in the world.  Gross Domestic Product (GDP) numbers are 50% higher than they ran in the past ten years. Interest rates are still historically low, unemployment numbers are low, wages are rising. These are the ingredients for a strong stock market. The future remains very bright.

Edward D. Foy, Manager, SELECTOR® Money Management. 

© 2018 Edward D. Foy.   [email protected],