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Recession, Expansions, and Bears - December 31, 2018

The Dow Jones Industrials1 lost 8.1% and the S&P 500 Index3 shed 8.2% between the Fed’s 2 p.m. ET announcement on Dec. 20 and Christmas Eve (Wall Street Journal). Given the holiday-shortened session on Monday, that’s a sizable loss in what amounts to about three-full trading days.

The Dow is down 18.8% from its early October peak, and the S&P 500 Index has given up 19.8% since its top in late September (St. Louis Federal Reserve data – through Xmas Eve most recent bottom).

A botched attempt by the US Treasury Secretary to calm investors on Xmas Eve and a Fed that can’t seem to communicate its policy stance have contributed to the sour mood. But program-trading likely exacerbated the drop, as a Wednesday article in the WSJ illustrated.

We’re not far from bear territory, which is generally defined as a 20% drop. Except for the 1987 market crash, which saw the Dow lose over 22% in one day, one must go back to 1966 to find a bear market that didn’t coincide with a recession. At the time the economy was slowing sharply, but growth picked up and the expansion didn’t end until late 1969 (NBER).

 

Now, it could be argued we have had “mild” bear markets that didn’t cross the 20.00% threshold.

Besides the current selloff, the Russian default in 1998 forced a decline of over 19% in just six weeks (St. Louis Fed). In 2011, the S&P 500 fell a similar amount thanks to a widening eurozone debt crisis, recession worries, and the USA’s loss of its triple-A credit rating by Standard & Poor’s.

We also came close to bear territory in the late 1970s, when rising inflation and rising interest rates pushed the S&P 500 Index down by 19% over an 18-month period (St. Louis Fed).

Going back to the end of WWII, bear or near-bear markets have been less painful and shorter, on average, when the decline didn’t accompany a recession.

Today, most leading economic indicators aren’t signaling a near-term recession. Sure, analysts and the market are fretting over various concerns, but it’s a Wall Street vs Main Street dichotomy. Note that Christmas sales this year have been strong, per a WSJ report. Therefore, December’s decline doesn’t seem to line up with the fundamentals.

What we know

Corrections and bear markets are inevitable. For some, withstanding selloffs may be unnerving and make it difficult to avoid the urge to sell during a big drop. In past declines, shares have recovered, taking the broad market averages to new highs.

Conversely, others take steep corrections or bear markets in stride, recognizing that markets can be unpredictable, and selloffs aren’t unusual. Besides, the investment plan helps reduce volatility while keeping investors on track to meet long-term financial goals.

Let’s not discount the fact that the market has historically had a long-term upward bias. Since 1950, the S&P 500 Index, including reinvested dividends, has risen on an annual basis 80% of the time (NY University Stern School of Business data on the S&P 500).

When 2018 comes to a close on Monday, it’s unlikely we’ll finish in the green. It will be the first annual decline since 2008.

One final note. Wednesday’s 1,086-point gain may or may not have marked the bottom (which, by the way, was the first-time ever the Dow has risen over 1,000 points in a day—CNBC). But when shares are extremely oversold on a short-term basis, any good news or a lack of an unsettling headline can create conditions for steep short-term rallies.


Please also be advised that our office will be closed on Tuesday, January 1st, 2019, in honor of New Year's Day. We will resume our regular operating hours on Wednesday, January 2nd, 2019, and wish all of our clients a happy and safe Near Year's Day with their families.

@LWMLLC