Market Madness

After many months of very smooth sailing and steady uptrend, the markets seemed to turn on a dime last week and produced two largest point drops in the Dow in history (both over 1,000 points) within the same week. There wasn’t any apparent reason for this sudden turbulence, but of course many market pundits rushed in to explain it. The consensus seems to be that the market dropped because everything is great. Too great, that is — an expanding economy, low unemployment rate, and generally favorable business climate — may awaken inflation leading to higher interest rates. It is true that in theory, higher interest rates put a damper in stocks, as bonds, traditional competition to stocks, become more attractive. The question is, how much higher will interest rates rise?

But these same concerns were valid one week ago, one month ago, and one year ago. Yet the market dropped this week. The simple reason behind it, as is the case in any market drop, was because there were more sellers than the buyers. That’s it. As it why it happened now — well, it had to happen sometime. A correction, or drop of at least 10% from the top, is a very common occurrence and happens, on average, every 18 months or so. The last one was in 2016, 2 years ago. Also, as I mentioned before, we had a very calm and rising market last year. We were overdue. By the way, just this week the market experienced more 1% fluctuations than in whole 2017!

The 4-digit point drops in the Dow, while impressive, don’t even make it to top 20 in terms of percentage drops. For now, I think this is typical garden variety correction. Historically, it takes an average of 4 months for the markets to recover to prior highs. Of course, more pain can always be ahead, but I don’t think this correction will turn to a full-fledged bear market (a drop of at least 20%). For that, a recession is usually required, and current economic situation is just too strong to allow that to happen.

After this drop, S&P 500 forward PE is at 16.3, very close to its 5-year average of 16, but still higher than it 10-year average of 14.3. In 2018, earnings are projected to rise 18.5% and revenue by 6.5%. Full three quarters of the companies reported positive earnings and revenue surprises for Q4 2017, so the analysts keep rising their earnings targets. My advice at this point, as always, is to keep calm and stick with high quality companies with strong fundamentals.