Every correction brings out calls for a “market crash”. Yes, the stock market will eventually crash and a bear market will begin. But based on the Medium-Long Term Model I don’t think that will happen until 1-2 years later (i.e. 2019-2020).
The current “small correction” is very standard. This is exactly how a lot of small corrections work (although the magnitude is a little larger than normal).
- 38.2-50% retracement bounce.
- Retest. Sometimes the retest makes a marginal new low, and sometimes the retest does not make a marginal new low.
That’s exactly what has happened so far.
The current “small correction’s” pattern reminds me of the July 2007 correction. There are a lot of similarities.
- The S&P crashes.
- Bounces 38.2-50% (fib retracement)
- Grinds lower in volatile trading but does not make a significantly lower low.
Here’s the S&P in 2007
Even these small corrections’ magnitudes are very similar.
- The S&P fell -11.9% in July-August 2007
- The current “small correction” is -11.8%
As expected, bearish traders and investors think that the recent decline is just the start of a 2007-like bear market or 1987-like crash. I disagree.
The stock market today is not like 2007 or 1987
- The 2007 analogue implies that the stock market will go up, make a new high, and fall into a bear market.
- The 1987 analogue implies that this is just the start of a massive correction.
I don’t think these 2 analogues are appropriate. There’s one huge difference between today and 2007/1987.
- The U.S. economy is clearly healthy and improving today. Key economic indicators continue to trend higher.
- Key U.S. economic indicators were trending lower and deteriorating for 1-2 years before 2007 and 1987.
*This is what I mean when I say “the economy leads the stock market”. The economy’s strength today will eventually lead the stock market higher. This is not a repeat of 2007 or 1987.
The economy in 2007
U.S. economic data had started to deteriorate by late-2005.
Here’s Nonfarm Private Payrolls, which started to trend down after 2005.
Initial Jobless Claims trended higher from 2006-2007.
Industrial Production growth fell from 2005-2007.
Here’s Housing Starts, which started to fall in 2006. (Housing Starts are trending higher today).
The economy in 1987
U.S. economic data had started to deteriorate by 1985.
Here’s Nonfarm Private Payrolls. This indicator had been trending down from 1984-1986, although it did go up for a few years after 1986 thanks to Reagan’s tax cut.
Initial Jobless Claims trended higher from 1984-1986.
Industrial Production growth fell from 1984-1986.
Here’s Housing Starts, which started to fall in 1986.
The stock market and economy move in sync over the long run. The stock market will inevitably mean revert to the economy’s direction when it deviates from the economy in the short-medium term.
The economy is improving today, which makes a 2007-style bear market or 1987-style crash very unlikely. The 2007 bear market and 1987 crash were preceded by clear signs of economic deterioration, particularly in the housing market (Housing Starts, New Home Sales, Existing Home Sales, Pending Sales).
It is time to reflect
Investors and traders should reflect every once in a while. I’ve been doing a bit of reflecting over the past few days. I’ve been thinking about what I did right and wrong in dealing with the stock market’s correction.
- I don’t think I made any mistakes with regards to my Medium-Long Term Model.
- I think I can improve the results with my Day Trading Model. My portfolio will benefit from these improvements very soon.
A lot of my friends and former colleagues have congratulated me for my timely correction call. They are too generous:
- The timing of my call wasn’t perfect. I didn’t call the exact top. But then again, nobody is perfect.
- It’s important to remember the role of luck in trading and investing. I laid out the most probable case: a correction in February. I was lucky enough that the market went along with that case. Trading/investing is about luck in the short run and probability in the long run.
- I don’t think I can call the next “small correction” so accurately. Small corrections are insanely hard to consistently and accurately predict.
In short, always be humble. Don’t feel terrible when you are wrong, and don’t feel like a genius/god when you are right. This reminds me of my favorite Tim McGraw song.
I find it distasteful when I see traders/fund managers pounding their chests and saying “I told you! I knew the correction was coming!”
- For starters, most of these bearish traders and fund managers were WAY TOO EARLY in their correction calls. Being early is just as bad as being late. These people were bearish throughout the entire second half of 2017. Timing is everything, and with the exception of a few their timing was very poor.
- Even worse are all the B & C list fund managers who are laughing at Ray Dalio for being bullish just before the correction began. A) Dalio’s time frame is 1.5 years. He’s bullish on stocks for the last 1-2 years of this bull market. He doesn’t care about corrections. B) These people need to learn some humility. One correction call does not make a career. These managers got one call right, but who’s worth $15 billion? Over the long run, it’s Ray Dalio that’s got the track record and not these fund managers.
- There’s no point in pounding your chest and bashing other people just because they made a wrong market call. Everyone makes mistakes. The market’s short term direction is notoriously hard to predict.
Read Study: this is not the start of a bear market