Five years of persistently slow growth and a sluggish labor market, increasing global instability and a new Fed Chair that openly contradicts herself — U.S. stocks seem to be able to shrug off any sort of news as long as there’s Fed stimulus to be had. Investors who have anticipated a correction in this “teflon market,” where bad news doesn’t stick, have been thwarted short squeeze by short squeeze. The latest argument for a market decline has been that we are overdue for a correction (a decline of 10% or more). Let’s take a look at the history of corrections by decade, from 1945-2014, and see just how overdue we might be.
The table below shows the percentage of overlapping periods when the month-end level of the S&P 500 has been at least 10% lower than the end-of-month level 1, 3, 6 and 12 months prior. Above-average frequencies are bold and shaded, with below-average frequencies in red.
The data show that decades characterized by an above-average frequency of corrections are reliably followed by approximately two decades of complacency, featuring a sharp decrease in the frequency of corrections.
Therefore, while it may feel as if stocks are overdue for a correction, it is not uncommon for stocks to remain in bull mode without correcting following a decade of volatility and low returns, such as the 1970s and 2000s. Stock values may correct for any of the usual reasons, such as an information shock or overvaluation concerns, but not for the simple reason that a correction is overdue. Thus far the 2010s are playing out similarly to the 1950-1969 and 1980-1999 periods in terms of having a below-average frequency of stock market corrections.
“It is difficult to get a man to understand something, when his salary depends on his not understanding it.” — Upton Sinclair
Market pundits seem to have the most difficult time embracing the concept of overvaluation. This morning on CNBC, Art Hogan once again demonstrated how to dance around the issue when he stated:
“What’s actually happening in the marketplace is, like it or not, the movement in the market mirrors almost exactly the move in earnings growth,” Hogan said. “If you look at how much the markets have gone up on a percentage basis, [earnings and the market are] almost identical or within a percentage point or two of each other.”
The following graph shows that Hogan is correct — the stock market and earnings have indeed grown at a similar rate since March 2009. However . . .
. . . the problem is that stock values since 1982 have increased 1600%, while earnings have grown about 600%.
Hogan focuses on one slice of the data — starting from an artificially-depressed bottom in earnings in March 2009 — and matches up the growth rates in the two series over the last cyclical bull cycle. Over the entire secular bull/bear cycle, however (1982-2013), stock values have appreciated at almost three times the rate of earnings growth.
Hogan tries to cram a secular, multi-decade bull/bear story into one cyclical bull market cycle, with the net effect of conflating the bull/bear/overvaluation debate. Just as he is paid to do.
Bottom line is the market will not correct until the final two indicators flash — when Ed Yardeni and Abby Joseph Cohen are trotted out to revive the “coordinated global boom” meme they pushed all the way up to the 2008 financial crisis — then you’ll know it’s time to run for the exits.