Over the past few weeks we’ve continued to watch the stock market gyrate as investors have held their breath wondering what it would do next. I released an article in July explaining that we were overdue for a correction based on historical patterns. Of course, corrections are part of the stock market’s typical behavior so much like a broken clock, I was bound to be correct at some point.
While a correction is painful enough, many investors are wondering if this is just a correction… or will this down market turn into a full blown calamity. Is this just a normal market correction or could it be the start of the next bear market?
Let’s look at some historical precedents. Going back to 1987, no bear market has unfolded that was not ultimately associated with a recession. When markets fall during a recessionary period the average drop is over 25%. However, corrections that were not associated with recessions only fell an average of 14.6%.
Here’s the good news: our economy is likely not going into a recession any time soon. The economy is doing well. Last quarter we had 3.7% GDP. I actually wrote another article a few months ago explaining how well our economy is doing. In addition to this good news, many of the areas where we saw warning lights flashing red in 2006 and 2007 are actually continuing to improve today including consumer confidence, housing data, consumer credit, and mortgage delinquencies.
To add a little more reassurance, let’s look at the Rule of 10 from Don Rissmiller, chief economist at Strategas. He believes that the economy is more apt to enter a recession when the average mortgage rate combined with the average cost for a gallon of gas is more than 10. With an estimate on today’s numbers this would translate to be: a 4.2% mortgage rate + $2.50 for a gallon of gas = 6.75, so we are safely below 10. Of course, this is simply a rule of thumb, but a good reminder that high gas prices and high mortgage rates ultimately have a slowing effect on the economy.
In knowing that recessions make market correction worse…we must ask ourselves, is the American economy cracking beneath the surface? For now and at least for the next year, I would say the answer is no.
If this economy holds and doesn’t slip into a recession, then the correction that we are currently in should stay a correction in the 12 – 18% range. In other words, long term investors will likely be well severed to “buy into the dip.” Think of this time as a sale on some of your favorite companies. Generally speaking, it takes an average of four months to recover from a 10-20% correction, and it takes 24 months to recover from a 20+% correction. While it will take some time for this current market to find solid ground, ultimately a strong underlying economy will translate into higher earnings for U.S. companies which is precisely what investors are waiting for.
Read the original article here.