We had our 10% correction – now what?

It generally never helps being short-term focused. Short term forecasts are notoriously unreliable and difficult to make. Therefore we try our best to stay away from this greater fool theory. But sometimes in our business, it is a necessary evil.

The first downward leg in a new equity bear market tends to be around 10%. A normal stock market correction is also around 10%. That’s why most people automatically assume that the first leg of a new bear market is nothing more than a correction within a continuing bull market.

bull market

Figure 1 – S&P 500 recent 10% correction from the high

At this point we have no idea if this is a routine correction or part of something bigger. The large reversal day on Thursday the 16th (after being down as much as 3% intra-day) followed by a (short-covering) rally on Friday indicates to us that an exhaustion low has been put in place. A close below 1820 on the S&P would increase awareness that a larger bear market has begun.

We have recently been using a service called Estimize. On their website, Estimize describes themselves as “An open financial estimates platform which facilitates the aggregation of fundamental estimates from [5,331] independent, buy-side, and sell-side analysts, along with those of private investors and students.” They claim their estimates are 67% more accurate than traditional street estimates because Estimizers are less conflicted when it comes to publishing their true views. We have NOT independently corroborated these assertions but they sound logical enough to us.

On a short-term basis Estimize sees Q3 2014 US Real GDP coming in at a healthy 2.6% (reports 10/30/14) and US change in Non-Farm Payrolls increasing to 275k (reports 11/7/14). Both are signs of a continuing, healthy, growing economy which is unlikely to spark an immediate bear market in the short-term. However, in our opinion, higher volatility is now likely with us for the foreseeable future, especially as important November elections loom.

That said, as day follows night there will be a bear market in our future – we are not to fear this as much as prepare for it. The significant widening of credit spreads over the past month, the high level of margin debt, the unusually low level of bearish sentiment, the underperformance of riskier assets classes such as small cap and international stocks all point to an ageing bull market which began in March 2009.

IF we are at the beginning of a larger bear market, history shows us that we are probably at least 12 months away from the start of any major equity liquidation. In more general terms, it usually takes a lot of time and a few failed rallies to shift the general sentiment from bullish complacency to “get me out at any price”.

WHAT TO DO?

We will seek to be more tactical, deploying assets selectively and generally into panic selling squalls. We will most likely continue to hold moderately higher cash levels and choose assets that generate income (interest/dividends) while having the potential for capital gains.

Best Regards

Greg
Greg Silberman CFA®, CAIA, CA(SA)

Chief Investment Officer

Advisory Services offered through Atlanta Capital Group.

Securities offered through Triad Advisors, Member FINRA / SIPC

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