Jan. 7, 2019 Commentary

The Time to Turn the Page to a New Year… and Gain Some Needed Perspective


“The stock market has forecast nine of the last five recessions.” -Paul A. Samuelson

What a year, and what a finish. And I had thought the market decline of 3.8 percent Thanksgiving week this year was annoying. That turned out to be a picnic compared to what was in store  in the month of December, including weekly declines in the S&P 500 of 4.6 percent, 1.3 percent, and 7.1 percent in the consecutive weeks of Dec. 3, Dec. 12 and Dec. 17, respectively, followed by a loss of more than 2.5 percent on Christmas Eve Day. About the only thing investors could say about the market this Christmas was, “Thank goodness it is closed for the holiday!”

Rather than a hoped-for Santa Claus rally, what resulted was a lump of coal in the form of a Santa Claus swoon. Fortunately, in my opinion we saw some rational thinking surface on Dec. 26 that lasted through the close of the year. Recognizing some real value had developed in stocks in this sizable December pull-back, investors were ready to do some bargain buying. The day after Christmas, the S&P 500 gained 5 percent and posted its largest single day point gain on record.1

Despite the rally that continued through the end of Christmas week, the headlines in the media continued to read, “Worst December since 1931!” While this could be tough stuff to digest, I also think such headlines are irresponsible. Yes, December was challenging, and, in fact, the entire fourth quarter period was disappointing, with the S&P 500 declining roughly 15 percent for the quarter. But, this ain’t no 1931! In fact, it is hard to believe that going into the first full week of December, the S&P 500 was actually up about 5 percent for the year and just about what was expected for the 2018 calendar year at that moment. Perhaps this correction could have occurred earlier in 2018, but it decided to appear at year-end instead. Once it began, I wrote that I thought it would be a process. And, while not reason to sell, I mentioned that I would be patient in buying into this dip until buying interest reappeared. And it was due. 

The keys are that I believe we are experiencing a fairly sharp but normal and healthy correction and not an extended bear market that is accompanied by economic recession. It seems many investors are simply too pessimistic and assuming worst case outcomes on virtually all major fronts. I believe the market fundamentals to remain quite positive. Yes, the economy and earnings are moderating, but to ok levels, not the horrible levels that many investors seems to be projecting. Valuation has quietly become attractive via the market pullback. This three part cocktail of solid growth, attractive prices and investor skepticism, I believe, sets the market up for double-digit gains in the S&P 500 Index (S&P 500) in 2019 as a base case scenario.

Is This a Bear Market?—Some Perspective

I keep hearing that the technical definition of a bear market is a minimum decline of 20 percent from a previous high in a stock market index such as the S&P 500. Where do I stand on this rather over-simplified barometer? The market peaked at 2,930.75 on Sept. 20, 2018, so the year-end close of roughly 2,500 puts us 14.6 percent below the September high. Based on this, we are not at bear market levels. 

That said, on Dec 26, the market came very close to hitting the bear market technical definition threshold of -20 percent on an intra-year basis when it hit an intraday low of 2,346.58. That put the market temporarily 19.9 percent below the peak in September, close to a bear market but not quite there. However, these figures are not out of the ordinary when compared to other periods of healthy cleansing. They are right in line with other corrective periods in this 10-year bull advance when we pulled back and subsequently moved onward. The following years are examples (returns below are price-only):2

  • 2009 – pullback of 28 percent intra-year, but finished up 23 percent for the year
  • 2010 – pullback of 16 percent intra-year, but finished up 13 percent for the year
  • 2011 – pullback of 19 percent intra-year, and finished flat for the year
  • 2015 – pullback of 12 percent intra-year, and finished down 2 percent for the year
  • 2016 – pullback of 13 percent intra-year, but finished up 10 percent for the year
  • 2018, pullback of 19.9 percent intra-year, and finished down 6.2 percent for the year

So, as you can see, it hasn’t been a straight shot to the moon and all rays of sunshine in these bull markets. These were all periods referred to as probable “market tops,” which rose higher for solid fundamental reasons. Remember the “Arab Spring” and U.S. debt downgrade in 2011, the China slowdown concerns of 2015, and the triumvirate of plunging oil prices, BREXIT, and a “likely crash if Trump is elected” in 2016? Fundamental strength eventually trumped the worrisome headlines, no pun intended. I’m just saying the current wall of worry fears aren’t longer or significantly different than what I’ve seen throughout this 10-year period of climbing a rolling wall of fears. 

However, the bear camp’s assertion that the market is in the midst of an ugly bear market is more complex in my mind than just the requirement that it hit the, so-called, minimum threshold of a 20 percent decline from the peak in the S&P 500 for a brief period. True bear markets that demand action on the part of investment advisors, in my view, are those characterized by a probable multi-year period of negative returns and, therefore, generally those accompanied by economic recession. 

My research has identified eight bear markets since 1970 that meet the technical definition via the 20 percent price decline threshold.3 Five of the eight are associated with economic recession, while three have occurred unaccompanied by recession. These latter periods are referred to as non-recession bears. It is telling that the recession bears were deeper and longer than non-recession declines. 

Specifically, the average decline of the recession bears was 36.2 percent versus the average decline of 23.9 percent for non-recession bears. In addition, the largest decline in the recession bears was 56.8 percent, represented by the 2007-2008 bear period. Conversely, the largest decline in non-recession bears was the 33.2 percent decline in 1987.4 This bear lasted only a few short months and the bottoming process was swift. 

The adjacent chart illustrates the nature (shorter and shallower) of non-recession “bears” such as 1987 and 1998, versus recession bears such as 2000-2002 and 2007-2008 that are very deep and painful. These recession bears are the types of risk moments that, when identified, command attention and a call to action. 

S&P 500 table

Source: Factset

These recessionary signals are not currently evident. What about the thought trumpeted by market pundits that the stock market is a leading indicator itself in terms of signaling recession? It’s true we should listen to what the market is trying to tell us as one of many metrics but, as Paul Samuelson said, “The stock market has signaled nine of the last five recessions.”5 Used as an isolated indicator, the stock market gives many false positives. And, Samuelson said this when fundamental analysis drove a good bit of trading activity versus today when the majority of trading is now driven by a combination of passive strategies and various algorithmic or rules-based investing that has much weaker linkage to true fundamental analysis and causation. 

The signals to look for to identify true moments of stress in the economy and financial markets are fundamental in nature and show historical value in signaling such moments. They include such items as trends in the slope of the yield curve, in the index levels of manufacturing and service economy activity, and in credit spreads, to name a few. In my opinion, this should be our focus, not headline fears or short-term price trends in stocks.

Myth—This Volatility is at Historic Highs 

This volatility myth just isn’t true, in my opinion. We hear this all the time in the media. Comments are made that this is just crazy levels of volatility. Yes, it has risen from the extremely low levels that spoiled us in 2017 and accelerated significantly in the fourth quarter, but the chart below says it all. Volatility isn’t anywhere close to historic high levels. The Volatility Index (VIX) or “fear gauge” that captures the volatility of options contracts is barely above long-term average levels and can more than double per previous moments of market stress a la 2007-2008. Further, the second chart below shows that volatility in the stock market, measured by daily percentage price swings in the S&P 500, was far higher in 2007 and 2008 than today. This looks more like pullback levels we saw in 2011 and not much different from 2015-2016. I believe the volatility “crisis” is exaggerated in the press.

CBOE Volatility Index VIX-CBO

Source: Factset

Daily Return of S&P 500

Source: Bloomberg

Update on the Wall of Worry

So, if fundamentals are ok, valuation (at less than 15 times earnings) has become downright appealing, and volatility has risen, but not to unreasonable levels, then why the horrible December? I choose to assign it, primarily, to over-pessimism about two key wall of worry Items: 1. Fed policy risk and 2. Fear that we’ll see a trade war rather than a resolution in trade terms via negotiation. 

While it are not likely to see perfection in resolving these two key issues, I believe, at these price levels, investors are assuming worst case results on both, which is unlikely. The Fed has no reason to be numb to economic data and continue hiking no matter what. It has already walked back Federal Reserve Chairman Jerome Powell’s October hawkish quotes, and, while the most recent December communication from the Fed on forward policy wasn’t an A+, the Fed said it will be data-dependent and reduced the number of hikes it anticipates in 2019. The market wanted more dovishness, but I take the Fed at its data-dependent word, and this is moving in the right direction. 

On trade, the market simply chooses to snub its nose at recent progress following the truce dinner between Trump and Xi Jinping in Argentina on Dec 1. Since then, the Chinese have announced:

  • New punishments to prevent IP theft
  • Intentions to re-initiate purchase of U.S. Ag products
  • A re-write of its “Made in China 2025” initiative toward more inclusive policies to the U.S.
  • A reduction in auto tariffs from 40 percent down to 15 percent

The U.S. trade delegation travels to China the week of Jan. 7. If that goes well, the Chinese contingent travels here the week of Jan. 14. Stay tuned… this could lift the market in 2019.


Don’t get me wrong, it’s not nirvana out there! If it were, there wouldn’t be any upside and stocks wouldn’t be trading at a reasonable average of 15 times earnings in the midst of solid economic and earnings growth. In addition to the two major wall of worry items mentioned above, mix in some government shutdown, some late-year 2018 tax loss selling, some elevated turnover in White House staff, and there is definitely some uncertainty to contend with. However, things are not as bad as they are being portrayed. I believe the key concerns highlighted above will be resolved in better-than-feared-fashion. Earnings growth going from great in 2018 to horrible in 2019 is very unlikely. I see it going from great to ok, which I believe supports the potential for double digit stock returns from these levels and many individual stocks priced at attractive valuation levels not seen in years.


1 Source: https://finance.yahoo.com/quote/%5EGSPC/history/

2 Source: JPMorgan and Factset

3 Source: Ned Davis Research

4 Calculated based on data provided by Ned Davis Research

5 1966 Newsweek article

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