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Is This Correction Over Yet?

Originally published in Reno Gazette Journal http://www.rgj.com/story/money/economy/2014/10/19/correction-yet/17494021/

I’ve never seen a market correction that wasn’t scary. And this one is no exception, especially since computer-based trading has significantly increased volatility. But, if we include the volatility, which means using intraday highs and lows, the intraday low on Wednesday was 9.8 percent lower than the intraday high on Sept. 19. By historical standards, neither a 7.4 percent nor a 9.8 percent correction is large, but this one has evoked some level of anxiety not seen in quite some time — maybe because we haven’t had this kind of correction since 2011. Or, perhaps, it is because the “average” stock is down much more than the S&P 500 index, which gives much more weight to the largest companies than, say, the Russell 2000 (a proxy for smaller companies) which, at its intraday low on Thursday, was 14.3 percent lower than at its intraday high on July 1.

• The “average” correction: Wall Street economist David Rosenberg has put together a compendium of what the “average correction” has looked like in the current 5.5 year post-recession period. According to Rosenberg, there have been 13 mini-corrections since March ’09. On average, during these corrections, the S&P 500 falls 8.7 percent over a 34-day span (the median decline is 7.2 percent over 28 days). So, the current S&P 500 decline, which began a month ago, looks to be about average.

Rosenberg also calculates that small-cap equity declines are 2 to 3 percentage points higher than those of the large-cap equities. This would put the average small-cap decline near 13 percent and, indeed, using closing prices for the Russell 2000, the decline from the closing high (July 3) to the closing low (Oct. 13) was 13.1 percent. Finally, during these episodes, the 10-year U.S. Treasury note also falls 40 basis points (.4 percentage points) in yield. On Sept. 17, the 10-year note yield closed at 2.62 percent; it was 2.16 percent on October 16, down 46 basis points. All of this confirms that, should the correction end now, it would be pretty average.

• No recession in sight: So, is it over? Since I don’t have a crystal ball, and averages can be misleading given that there are such things as standard deviations that accompany the analysis of any average, I can’t say. But I do know that major downdrafts in equity prices are almost always accompanied by oncoming recessions. And, while Europe, Japan, South America, and maybe even China may be headed for recession, the current evidence is that the U.S. is not. In fact, in the post-World-War II era, every recession has been preceded by a yield curve inversion (short-term interest rates higher than long-term interest rates), and since the 1970s, every recession has been preceded by rising oil prices. Today, we have no prospect of a yield curve inversion, and energy prices are now in a bear market. Since there is no prospect of recession, it is likely that this is just an ordinary, “run of the mill,” correction (with added volatility). The markets have been reacting to the four Es (Ebola, Europe, earnings and energy).

• Ebola and other geopolitical events have taken some wind out of consumer confidence, and when this happens, consumers tend to tighten their belts.

• The sputtering European, Japanese, and South American economies along with slowing growth in China have strengthened the dollar and caused worries, reinforced by various Fed speakers, that in the near-term, the U.S. would be importing deflation (caused by lower dollar prices of imported goods).

• Earnings are a concern for multinational corporations with slowing sales in those sputtering economies and now there is an additional currency translation issue, i.e., a stronger dollar means lower translation values of foreign currency sales.

• Falling Energy prices, while an issue for big oil and maybe for the Russian ruble or some Middle East sheikdoms, are a huge boon for U.S. consumers.

Tailwinds Benefit U.S. Consumers: Consumption represents 70 percent of U.S. GDP, and the tailwinds are significant. Lower energy costs, a deleveraged U.S. consumer and continuing low interest rates are factors that are likely to swamp the slower growth in the rest of the world, the stronger dollar, or any earnings concerns. The American consumer doesn’t live in the rest of the world; she lives in the U.S.!

Of course, my analysis is not a guarantee of future results. You should consult your own financial adviser to determine your appropriate asset allocation and if you can tolerate the volatility and risks inherent in taking any such action.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, a Registered Investment Advisor.  Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.  Robert is available to discuss client investment needs. Call him at (775) 284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV  89521.  Ph: (775) 284-7778.

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