Dow, S&P 500 fears? Worrying about a correction is wrong way to invest

The Dow Jones Industrial Average and S&P 500 Index just suffered five straight days of losses and their worst weekly performance since — wait for it — June. Investors went into the summer easing up a little bit on stocks and have exited the summer with a similar bout of selling. Is there any more to it? Is the big one — the stock market correction bears have been waiting for — finally about to drop?

Many of the major factors cited for a potential selloff are well-known to investors, implying it is harder to see how at this point they would be the ones to cause a correction. There’s the delta variant. There’s the Federal Reserve taper and shift in central bank policy amid a sudden slowdown in job and economic growth. There’s the latest political headline — new wrangling in Washington D.C. over a corporate tax hike and potential tax on stock buybacks to help fund President Biden’s spending plan.

And there is the issue that has trailed stocks at every new record set during this bull market (and the bull market that preceded, or depending on your view, was interrupted by the pandemic): stock valuations are high.

There are also short-term pressures to consider: the “seasonal choppiness” of the fall, which market strategists say is real, and recent U.S. equity market downgrades from major Wall Street banks, which could keep pressure on shares, especially with so much of the recent money coming into the market from retail investors. But it is always more likely something investors can’t see coming (such as a pandemic) causes a historic market selloff than everything investors already know.

That makes technical market indicators and the historical performance of the S&P 500 one reasonable way to gauge whether investor confidence will outlast the latest round of selling.

Johannes Eisele | AFP | Getty Images

For Keith Lerner, co-chief investment officer and chief market strategist at Truist, the history of the S&P 500 suggests that the bull market isn’t done yet, even if gains moderate.

Since 1950, there have been 14 years where the market has been up more than 15% through August. Stocks went on to add another 4% by year end, on average, and climbed in 12 of the 14 instances.

Stock selloffs are to be expected

Pullbacks are to be expected. The deepest pullback in 2021 has been roughly 4%. That is not typical, according to Lerner’s review of the data. The only two years in the historical data set that did not see at least a 5% pullback in the S&P 500 were 1995 and 2017. And history says gains that occur rapidly have to slow down. Lerner notes in his research to clients that the current bull market has gained 102% in 1.4 years versus the average bull market gain of 179% over 5.8 years since 1950.

But following what Lerner calls the “weight of the evidence approach” in the technical indicators and macro environment, the message for investors — not traders looking for every short-term move to make —is that U.S. stocks can still go higher over the next six to 12 months.

Last week’s losing streak, in his view, is not something to be alarmed about after one of the strongest starts to a year in several decades. Often when the market moves a lot the automatic reaction is to say it has to ultimately become a negative, but Lerner says investors should not fear strength as long as it is supported by fundamentals. “A trend in motion is more likely to stay in motion,” he said. “The carousel of concerns continues to turn and when one concern recedes another pops up to take its place. There is always something to be concerned about … there always can be something we are not talking about today that can sideswipe us.” 

Even if the black swan event doesn’t materialize, that doesn’t mean there won’t be 3% to 5% corrections. “That’s the admissions price to the market,” Lerner said.

It doesn’t mean investors should never make tactical moves, but he says for the majority of investors it is better to stay focused on the next big move over the longer-term than the next move among traders.

Slowing economic growth isn’t no growth

The economy may fall short of the rosiest expectations for a “roaring 20s,” but Lerner is focused on the fact that a slower expansion still isn’t a recession and stocks rise 85% of time in periods of economic expansion. Stocks are valued highly, but he noted that the price-to-earnings ratio of the S&P 500 has not been making new highs this year even as the market as a whole has been.

“Valuations are still rich so we don’t expect much P/E expansion, and then its earnings growth driving, so stocks can’t grow at that same pace.” But he added that after the pandemic crash, analysts had underappreciated the strength of earnings as a whole.

That happens after recessions, it happened after 2009, he said: estimates are cut…

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Dow, S&P 500 fears? Worrying about a correction is wrong way to invest

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