Market corrections are a process
Economic fundamentals remain sound
- The S&P 500 Index entered correction territory on February 8, 2018, closing more than 10% below its peak on January 26, 2018.
- The market downturn comes on the heels of an extended bull market with very low volatility on a historical basis.
- Market corrections typically take time, but the global economy and earnings appear poised to continue growing in 2018.
While market corrections are never comfortable, it is important to remember that they are a regular feature of equity markets. Prior to February, the S&P 500 had experienced its longest stretch ever — over 400 trading days — without even a 5% drawdown. This was historically exceptional.
In our view, the current downturn has the characteristics of a correction in the course of a long-term economic expansion. While all sectors have experienced declines, the dispersion has not been wide. Equity market performance continues to be led by cyclical stocks rather than defensives, reflecting a degree of investor confidence in the economy.
Importantly, signs of stress are not evident in the high-yield or credit markets. Yields on the 10-year Treasury note have consolidated in the 2.75% to 2.80% range. Falling yields would be an indicator of a risk-off trade. Meanwhile, credit spreads have been relatively stable rather than widening as they typically do when there are concerns about corporate earnings.
Fundamentals remain sound
Markets are now in a process of adjusting to dramatic investor sentiment as well as risk perceptions about interest rates and inflation. It is probably too early to expect stability.
At the same time, it is worth remembering that equity markets in the long term focus on future corporate earnings, and this picture remains bright. The U.S. and global economies appear likely to continue expanding, and could support double-digit growth in earnings. Also, the recent tax reform is likely to add to growth this year. The likelihood of an economic recession remains low, in our view, and should provide a supportive backdrop for the equity market.