NEW YORK — Is it safe to come out now?
The stock market has found firmer footing following its breathtaking drop earlier this month, when the S&P 500 lost 10.2 per cent in just nine days. Stocks climbed Tuesday for the third straight day, and the S&P 500 is now down 7.3 per cent from its record high, set on Jan. 26.
But investors have seen this playbook before. Even in past recoveries, it has sometimes taken months or more for momentum to fully turn around.
Here’s a look at what history shows about past corrections, and what market watchers are expecting going forward.
Q: How bad was this market drop?
A: Drops of 10 per cent or more for stocks are regular occurrences but the speed with which this last correction struck was unusual. Only 19 times since World War II has the S&P 500 lost at least 10 per cent in 10 days or fewer, according to strategists at UBS.
Besides this month’s sell-off, those rapid retreats include a drop in August 2015 sparked by worries about slowing economic growth for China and a plunge in August 2011 after the U.S. credit rating got downgraded from AAA and worries about Europe’s debt crisis were near their peak.
Q: What happened after the last such corrections?
A: Months of muddling along.
In August 2015, the S&P 500 lost 11.1 per cent in six days. That was followed by two straight days of big gains, each at least 2.4 per cent, a sign that the worst could be over.
But stocks ended up bobbing higher and lower for months. The market recovered all its losses by November, only to fall back into correction territory again by the ensuing January. It took 15 months for the index to climb 5 per cent above where it was when the August 2015 slide began.
After the 2011 correction, where the S&P 500 fell 11.2 per cent in three days, it took nearly three months for the index to claw back all its losses.
Q: Before this month’s drop, analysts were saying the stock market was expensive. Is it cheap now?
A: It’s cheaper, but not necessarily cheap.
Analysts look at several measures to gauge how expensive stocks are, and many of these measures are lower than they were a couple weeks ago but still above their long-term averages.
The S&P 500 trades at 16.8 times its expected earnings over the coming 12 months, for example. That’s a more attractive price-earnings ratio than the 18.6 it sported when the index set its record on Jan. 26. But it remains more expensive than its median of 14.8 over the last 15 years.
“Back in 2009, I knew that it couldn’t go much lower because I’d never in my life seen valuations as good as they were, but we’re not at that point yet,” said David Brown, chief market strategist at Sabrient Systems.
Q: So, is this most recent correction all over?
A: In truth, no one knows. But many market pros say that they’re confident the stock market will recover and eventually reach new heights. They don’t see this as another market catastrophe like the Great Recession, which caused stock funds to lose half their value.
“I think the big one will come at some point, but typically to get a sustained drawdown you have to have a recession,” said Brad McMillan, chief investment officer at Commonwealth Financial Network. “We’re not looking like we’ll have one of those for at least six months.”
Plus, corporate earnings are going up. That helps make the market look less expensive. A stock’s price-earnings ratio can go down in two ways: Either its price falls, or earnings rise. Both seem to be occurring now.
A little more than two thirds of the companies in the S&P 500 index have reported how much they earned in the last three months of 2017, and they’re on pace to show growth of 14 per cent from a year earlier, according to S&P Global Market Intelligence.
Q: What could trip things up?
A: The threat of higher inflation — and of the Federal Reserve jacking up interest rates quickly in response — is what triggered this most recent sell-off.
That’s why Wednesday’s report on the consumer price index is circled on traders’ calendars. If inflation proves to be higher than the market expects, it could trigger another sell-off in bonds that carries over into the stock market.
Other highlighted events include Feb. 28, when Fed Chairman Jerome Powell will deliver a report on monetary policy to the House of Representatives, and March 21, when Powell is scheduled to hold a press conference following the Fed’s next policy-making meeting.
Q: Is everyone optimistic?
A: No. Some skeptics say they would feel more comfortable if stocks had fallen enough to clearly qualify as “cheap.”
And while most economists are confident the economy will keep growing in 2018, some investors are warning about the years following.
“The risks of a recession in the next 18-24 months are rising,” hedge fund titan Ray Dalio wrote in a recent post on LinkedIn, as the Federal Reserve feels more pressure to raise interest rates when wages are rising and a growing economy is getting more stimulus.
“While most market players are focusing on the strong 2018, we are focusing more on 2019 and 2020.”
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