This has been a difficult start to 2014 and now the popular press is bombarding us with data about how a poor January statistically means that the year will be negative.
It is important to remember that what just happened can’t be changed; instead, we need to focus on the remaining 11 months of 2014 and beyond.
History shows that after a weak January, the remaining 11months are a toss-up in terms of up or down. With that in mind, let’s think about 2 questions: Why are equities weak? and What happens next?
I would suggest that no one knows the answer to either question, but markets rarely go in one direction uninterrupted. US stocks were up in excess of 30% last year with very little draw down and below average volatility. Strategists have been calling for a correction for a while and it looks like we have the start of one, which in some ways is healthy for future gains.
A few stats to keep in mind: Since the end of World War II (1945), there have been 27 corrections of 10% or more, versus only 12 full-blown bear markets (with losses of 20% +).
This equates to one correction roughly every 20 months, according to Dow Jones, who points out that this average does not mean they’re evenly spaced out. 25% of these corrections over the last 66 years occurred during the 1970’s (the Golden Age of MarketTimers), another 20% occurred during the secular bear market of 2000-2010.
The average decline during these 27 episodes has been 13.3% and they’ve taken an average of 71 days to play out (just over three months).
There are multiple factors to blame for the recent weakness: Emerging Market (EM) troubles, Fed tapering, earning’s concerns, etc. I would suggest you are seeing some recalibration of risk in portfolios after an unbelievably strong 2013. Most of the rest is noise.In other words you are seeing some folks rebalance at the same time they are de-risking portfolios by adding more defensive equities (i.e. out of EM, into developed) and more in bonds.
I have no idea how long it will last or how low it will go but I still believe conditions are generally good for stocks.
All in all, the economy is generally accelerating and becoming more self-sustaining (hence tapering), inflation is low, monetary policy is accommodative, valuations are pretty average (better than they were a month ago). Typically when you get those conditions stocks do better.
In fact, recently most of the strategists we talk to look for mid-single digit earnings growth and stocks up mid to high single digits from here to end of 2014. Barring a major surprise I think that is reasonable. 2% to 3% dividends plus 4% to 5% earnings and no multiple expansion (all very reasonable) and you get high single digit returns.
There is one caveat; I do think the economic data including this Friday’s employment report will be a little weak.We had really bad weather in December which will skew the numbers. This probably means some more downside, but once we work through December/January data, the economic trajectory had been looking better.
Just remember, stock investors are not complacent about risk and valuations aren’t extended. That gives me great comfort, and should do the same for you.