When markets continue to trade higher with only 5% pullbacks along the way investors have a tendency to become complacent and forget about the fact that normal market corrections (selloffs of 10%) do occur on average every 12-18 months. Since the last defined market correction was back in August of 2011, it appears that the current selloff was overdue and thus was more rapid and intense than many were expecting.
While there has been no single catalyst for the recent selloff, further weakness in Chinese economic data has been the primary driver. As such, fears of a global slowdown are contributing to this substantial volatility. Some pundits suggest that a slowdown in foreign markets will eventually spill over to the U.S. We believe these fears are overblown.
Furthermore, we do not believe that this is a prelude to another 2008-style crash. That was a unique period in which the entire world’s financial system almost collapsed. Today, our banking system is on much more solid ground. It should be comforting to know that recent stress tests of extreme scenarios illustrate that banks have enough capital to withstand a 60% market drop, a 25% reduction in home prices, and an unemployment rate above 10%. Just this morning, the Commerce Department revised its second –quarter GDP numbers to show that the US economy is growing at a healthy 3.7% annual pace! This was much higher than the initial reading of 2.3%. Leading economic indicators are still positive for the US, and lower oil prices and interest rates should help stabilize growth.
The key question during these events is… where is the bottom? Although this is impossible to tell, our experience leads us to believe that the worst of the correction has already occurred. While volatility should remain high and a retest of the lows is possible, we believe the market will be trading at higher levels by year end. In fact, if you take the last 15 times the S&P 500 has traded down 6% or more in one day, it was higher one year later 86% of the time by an average of 21.43%.
The recent selling has restored value in some areas of the market. We continue to like Financials, Health Care and Technology. Therefore, we are focusing our efforts at this time on increasing exposure to those high quality companies and ensuring proper allocation for all accounts. As Warren Buffet famously quoted, “Be Greedy When Others are Fearful.”