Corrections

Old age alone may not kill the bull, but it can make it more susceptible to an array of life-threatening maladies.

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Old age has certainly put no limitations on the bull’s exploits, so we should be cautious in reading too much into its meandering recovery path. However, it’s possible that action since the February low is not a recovery process but rather a countertrend bounce within a larger downtrend.

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2018’s S&P 500 setback qualifies as an “intermediate” correction. Historically, the duration of intermediate corrections is brief, and recovery time to move back above prior highs has also been brief. This year’s retracement route is already among the most meandering of all recovery paths since 1950.

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In difficult markets, we have become more appreciative of some of life’s small gifts. For example, it’s been quite a while since we’ve heard it argued that this is “the most hated bull market of all time.”

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While the January 26th bull market high illustrated none of the hallmarks of a major cyclical top, there are secondary signs that a stealthy distribution process may be underway, such as an overwhelming bias toward opening market strength followed by intraday weakness.

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Yields on 10-year Treasuries are up 10 bps since stocks peaked in January, a clear break from the behavior of prior corrections. The last four stock declines of 10%+ were self-medicating—having been accompanied by bond yield declines of 50 to 150 basis points.

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Our shortest-term put/call measure has yet to reflect the level of fear usually triggered by a correction of this size. Meanwhile, the market setback has done almost nothing to stymy the optimism of either market newsletter writers or mutual fund timers.

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For the first time in this bull market, defensive stocks failed to provide any semblance of defense during a market correction.

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The stock market’s nine-day decline off its January 26th high met our definition of an intermediate correction—an S&P 500 loss of between 7-12%.

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The setback from the January 26th market peak represents the ninth correction of 7% or more since 2009, the most ever recorded during a single cyclical bull market.

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We believe the decline from the broadly-inclusive market highs of late January is a yet another late-cycle correction and not the first installment of something more sinister.

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So, what happened to the January Barometer—the old analyst’s maxim that a market gain in January portends a gain for the full year?

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The most common 2018 time-cycle pattern among major markets is a fall correction, with the U.S. and Japan faring better than their European counterparts.

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The S&P 500 and DJIA were up 10-11% on the year through early August—solid, but not quite the “melt-up” scenario we’d envisioned earlier this year…We think S&P 500 2,550-2,600 will be achieved, but not until year-end…

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Through early August, the S&P 500 had matched last year’s total return gain of 12%, while futures on that index have gained more than 20% from their after-hours lows made on election night.

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Our disciplines remain bullish, but we periodically wonder whether we’re being too cavalier in keeping our tactical portfolios “almost” fully-invested (at 65% equities) in the face of valuations that are higher than those seen in all but perhaps 24 months of stock market history.

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The correction failed to meaningfully “reset” any long-term valuation measures, hence, we don’t view the current environment as having much investment merit, but rather, primarily speculative appeal.

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If our market disciplines turn bullish in the weeks ahead, we’ll certainly follow that lead—covering remaining shorts, re-establishing a semi-aggressive market position, and wiping egg off our faces for having called a “cyclical bear market” that slammed the Russell 2000 (-26%), EAFE (-26%), and Emerging Markets (-37%)… but somehow not the one most followed, the S&P 500 (-14%).

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If February 11th marks a lasting low for stocks, the 2015-16 decline will go down as one of the costliest in history not to have reached bear market status.

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At its January 20th closing low, the S&P 500’s peak-to-trough decline of –12.7% barely met our definition of a severe market correction (an S&P 500 loss of 12% to 18%). But the behavior of this particular index can be quite sinister during the final phase of a bull market—and during much of the ensuing bear.

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