No Sleeping at the Wheel II

For only the second time since 2011, the equity markets have sold off more than 10%. Typically in a rising stock market driven by a growing economic cycle, we experience a 10-15% pull-back once every year. We view this type of market action as a healthy exhale. From historical highs set on January 22, the Dow Jones Industrial Average has dropped -6.72%, and the VIX, (CBOE Volatility Index) has spiked a dizzying 184%. We avoid making short-term predictions, but view this dip as what will play out as a very short-term technical sell-off. For the stock market to enter a sustained bear market, the underlying economy must first enter recession. Two things happen in advance of a recession – the Leading Economic Indicators drop for several consecutive months, and the yield curve inverts, which is a fancy way of saying short-term interest rates rise above long-term interest rates. Neither of these fundamental conditions currently exists, and we believe it will take at least 12-18 months for either of those two conditions to develop. Once the LEI’s drop and the yield curve inverts, it typically takes several months for the underlying economy to slow. We have gone on the record that the current secular bull market will last a minimum of 2 1/2 more years, and nothing in the markets or economy has fundamentally changed over the past two weeks to change that outlook.

The last time this happened was on August 21, 2015. The U.S. equity markets lost over 3% in one day, snapping investors awake from the lazy days of late summer. For the first time since 2011, the markets had dropped more than 10% from their recent all-time record highs. We published an article back then that we viewed the drop as a healthy exhale and a potential opportunity for investors to move cash into the market. Usually it takes 15% to get our attention, but a few key occurrences grabbed our attention that summer. That day, the VIX (volatility index) rose a dizzying 46%, and the breadth of declining stocks represented well over 90%. The yield curve was normal (upward sloping) and the Leading Economic Indicators were rising, so we viewed the sharp sell-off as short lived. A year later patient investors were rewarded with a 6% rise in the market.

© 2018 Pawleys Investment Advisors, LLC. All rights reserved.

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