Following the longest period in history without a pullback in the stock market, February 2018 saw the return of market volatility. Understandably, everyone is wondering what that means for investors going forward. After a significant jump in January of 2018, the markets pulled back close to 10% which is, in fact, the traditional definition of a correction. The markets have subsequently bounced back and regained around 60% of that loss, but closed the month of February with two down days in a row. So, volatility is back and the question is: what’s next?
For anyone who has studied the history of the equity markets, it is clear that volatility is and will always be, a normal part of investing. Any number of events can trigger volatility. Such events go as far back in time as the Tulip Mania Bubble in the Netherlands in 1637. In more recent times, we saw the 1998 Russian financial crisis, the 2000 Dot-com bubble, and the 2010 European Sovereign debt crisis. However, just because volatility has finally returned doesn’t mean that the bull market is ending.
Historically, bull markets do not end based on one single event but rather have shown technical indicators deteriorating over a period of time of at least 4-6 months prior to the top of the market, according to Lowry Research. These early warning signs have given investors time to position defensively well in advance of a major bear market.
Prior to the most recent market high, most of these technical indicators were not, in fact, breaking down. On the contrary, they were actually improving and hitting more positive levels. This would seem to indicate that the recent period of volatility was a way to reduce the excesses that have built up in the markets over the last 12-13 months. This is a healthy process that allows the market to cool off and build a stronger base giving it the potential to achieve new highs in the coming weeks and months.
Roger Ingwersen, founder and managing principal of The Harvest Group, offers a reassuring perspective based on more than 45 years of experience, during which he has seen the good, the bad and the ugly. The ugliest was October 19th, 1987. This was the biggest one day of volatility when the Dow Jones Industrial Average (DJIA) dropped 22.6%. In the financial world, October 19, 1987 is known as Black Monday. To make matters worse, the previous Friday, October 16th, 1987, the DJIA fell 4.6%, thus resulting in a two day drop of over 27%. News outlets reported worldwide financial panic and that investors were scared to death.
We have heard some comments from investors and analysts that certain conditions in the current economy are similar to what preceded the crash of 1987. While there may be some comparisons in fundamental indicators that could fit their narrative, we don’t see those similarities in the underlying technical indicators. One of these in particular is the growing level of buying power since November 2016 and declining selling pressure which has been in a confirmed downtrend since then as well. Lowry Research Corporation’s buying power and selling pressure indices represent a method for showing the forces of supply and demand at work, and provide a tangible means to continuously evaluate the underlying condition of the market. For example, selling pressure back in 1987 was in an uptrend and crossed over buying power prior to the crash of 1987 which was a sign that something was bubbling beneath the surface prior to that fateful day.
Not only is the technical picture looking healthier today than it did even 2 years ago, the fundamental outlook has firmed up as well. After stagnant company sales and earnings over the last few years, there is the potential for improvement as a result of recent tax cuts. Not only are company earnings set to improve, but US taxpayers should be seeing an increase in their net take-home pay as well.
Volatility has always been a part of the stock market world and even though it has been absent for a period of time, its return doesn’t mean the end of the bull market that started in 2009. However, one of the many assumed responsibilities of Certified Financial Planner™ professionals is to help clients keep an eye on the long term and help them survive the market volatility that it is sure to come in the future with well-designed investment strategies that are monitored on a regular basis.
Far less widely reported about the year 1987, is that the DJIA actually finished the year at a positive 2.26%. The Standard & Poor 500 finished the year at a positive 5.81%. While everyone else back then was close to panic, Roger Ingwersen told his clients to go home, have dinner and a drink and not to feed into the constant fearmongering being reported by the media. Unfortunately, those investors who panicked on Black Monday and who sold, missed out on the recovery that followed. Professional financial advisors can help investors to stay focused on the long term and to remind them that investing in the market is not a sprint, it is a marathon.