As you know, I’ve been tracking three volatility-related record streaks in real-time with you. The first two streaks (1) number of consecutive days without a daily decline ended on January 29th, and (2) number of consecutive days without back-to-back 0.25% declines ended the following day.
Streak #3 was the number of consecutive days without a 5% correction. In Volatility Update #2 (January 30th), I mentioned that this streak would end before year-end, “and, maybe, even before the first quarter is over.”
Well, today, before the end of the first quarter, this streak finally met its end at a hair over 400 days.
The S&P 500 peaked at $2,872.87 on January 26th. Today, the S&P 500’s low was $2,638.17 for more than an 8% decline from the peak. The S&P 500 closed the day at about $2,649 for a 4.1% decline on the day. At one point today, the Dow Jones Industrial Average was down 1,500 points! The Dow closed down almost 1,200 points for a 4.6% decline.
I was pleased to see bonds finally doing their job again today. High-quality, investment-grade bonds were up, which, for diversified investors, helps to mitigate some of the losses in stocks. Gold also acted as a safe haven it can sometimes be as it managed to squeak out a gain of about 0.25% as well.
What Does This Mean Going Forward?
It’s no secret I have been anticipating a severe bear market. I’ve been quite outspoken about it, which is why I have clients positioned more conservatively than I would if I believed we were in a fairly-valued environment. But the million-dollar question, and the one a couple of you asked me today, is, “Is this the correction you’ve been talking about?”
No, this is not THE correction, but I don’t know if this is the beginning of it or merely a temporary pullback before a rebound.
Historically, it’s not common to transition from a period of extremely low volatility directly into a bear market. It’s possible but not common. Normally, before a bear market, daily movements gradually get larger and volatility increases. This could last for many months before the ultimate peak and bear market. These are like foreshocks before an earthquake. So I can’t say with certainty that $2,872 is necessarily the peak because it’s possible this is merely one of those foreshocks before the market rebounds again.
Alternatively, today’s market is different than the past in a couple ways. Volatility has been at record lows while valuations higher than they’ve ever been. Additionally, flows into stocks in January were enormous, cash levels were at historic lows, and equity allocations at historic highs. This dispersion indicates an abundance of potential stored energy. If that energy gets released you could see a cascade of selling that feeds on itself, much like you’ve seen over the last couple days and more.
Think of two plates in the earth’s crust pressing and rubbing against each other with huge pressures building. What happens when that pressure is released? A massive earthquake. It’s the same concept. Pent-up energy and pressures that build up must ultimately get released. That’s essentially the function of market corrections -> a release of energy that flushes speculators and weak hands out. The longer you go without a pressure release, much like we have over the last two years, the more potential energy is stored and the more severe the ultimate earthquake.
So I cannot say with certainty if the top is in or not. You only know it’s a bear market when it’s in the rearview mirror. I am confident, however, that valuations are about as extreme as they’ve ever been so, instead of trying to time the market over very short periods and take excessive risk, I’ve done the opposite. I’ve made the decision to build more protection around client portfolios by making them more conservative than they’d be in a fairly-valued environment. It helps investors to sleep better at night and to stay the course during adverse markets, which increases their probability of achieving their financial goals. It also reduces potential losses. After all, whether or not this is the beginning of a new bear market, a bear market will ultimately come and valuations will have to correct. That will lead to severe losses, and THAT will be the time to get more aggressive again.