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Volatility is back.


1,793 points. That is how many points the Dow went up in the first 15 trading days of January.
The Dow Jones Industrial Average (DJIA) was 24,824* on Jan 2nd  and at that time many experts felt it was too high. But by January 26th the DJIA reached 26,617.* A better than 7% increase in a little over two weeks.
The market is like an escalator when it goes up, and like an elevator when it goes down. And it never feels good when it goes down. We don’t know for sure, but we believe this is the long overdue correction that we have anticipated for many months now.
We don’t believe this is the beginning of a long and drawn-out bear market for stocks.
The stock market is often a leading indicator (it usually forecasts economic activity and profits 6-12 months out). The rise in the stock markets since 2016 bears that out as we now see the economy and company profits growing.
Although there is no foolproof way to predict the future, our investment team believes that we are most likely in the middle of an elongated business cycle that has grown slowly since the last deep recession.
We don’t think we are at the end of the business cycle. That is why we see this as a market correction, not as an indicator of a looming recession.
Long-time investment strategist Richard Bernstein recently wrote: “The recent market volatility seems to be a result of investors finally realizing that the business cycle isn’t dead. Later-cycle inflation is becoming more obvious, and the market has needed to recalibrate valuations, earnings expectations, and asset allocations to the suddenly “new” inflationary environment.”**
We tend to agree.
Since 1960 there have been no fewer than 13 non-recessionary corrections of at least 10% for the S&P 500. The average length is 144 days (which to most investors feels like a lifetime). The average decline is 16.1%, and interestingly (almost 11 out of 13 times) when company’s earnings are increasing. A good example was the one day plunge that happened in 1987. At that time profits were up more than 50% on a year to year basis. On average during these corrective phases earnings are not just positive but up by more than 20%. ***.
This correction doesn’t feel that much different.
So the question is: “Why do markets correct when profits are still going up?” Because the market often acts irrationally and moves in fear and greed modes going from overbought conditions coupled with excessive valuations (like we had on January 26th) to undervalued and lower valuations. Corrections are not fun, but they are normal and last longer than most investors like. But once they are over, history has proven time and time again that stocks move higher.
As an added note, the chart below shows what has happened one year later after a one day plunge we have seen recently. Nine out of ten seem like pretty good odds, don’t they?
* Source Morningstar
** Source© 2018 Richard Bernstein Advisors LLC
*** Source Barron’s