Before this month, a drop of 10 percent from an all-time high in less than two weeks hadn't happened since 1928. A look at other, similar sudden market breaks from history shows a relatively encouraging pattern of a fairly quick recovery. One has to look back to 1955, 1980 and 1986. There are also some echoes of the late-'90s gut checks, the 1997 Asian currency crisis and the 1998 Long-Term Capital Management meltdown.
Bespoke Investment Group points out the S&P 500 had only gone from "extremely overbought" to "extremely oversold" (as statistically defined) in less than two weeks 21 times before this correction. Most instances were not within, or at the start of, bear markets. Forward returns thereafter were pretty good, on average, though some continued turbulence wasn't uncommon.
For what it's worth, bull markets tend not to end for good the way that "melt-up" into January did, as discussed here in mid-January. Urban Carmel, a veteran trader and market blogger, has a helpful roundup of the fundamental, technical and sentiment situation here.
His central takeaway: "That equities have quickly recovered from previous swift falls that started from a high should not be a surprise. Strong uptrends carry momentum that typically weakens before failing completely. The implication, however, is that for the first time since early 2016, the trend in equities is on watch. A recovery to prior highs followed by more volatility creates the sawtooth pattern that is most often found at important tops."
While on watch, it's crucial to track macro signals outside of stocks. For now, it's a net positive that the credit markets are not showing the sort of stress that would imply economic or liquidity problems — as happened in 2015, when a similar "volatility shock" and quant-fund meltdown segued into a macro scare as junk bonds, oil and global earnings were hit hard.
It would be unusual for stocks to go down a lot more, and stay down, given the path of corporate profits this year. Here, FactSet shows the trajectory of 2018 earnings forecasts steeply rising (largely due to tax-cut and weak-dollar effects, but still).
It's not unprecedented for stocks to struggle even as corporate earnings surge. This happened in 2011 and in 1994, when the broad indexes were flattish, with many sectors struggling and the market sustaining whippy volatility and macro scares along the way.
Legions of Wall Street strategists last week were out declaring "the fundamentals have not changed." This is not wrong, exactly, but also not the real point.Not broken, just bent
This is a valuation, sentiment and investor-positioning reset, with an exacerbating "X-factor" of a crowded volatility-trade unwind.
The market was likely overpaying for good fundamentals two weeks ago, and investors were giddily extrapolating the good news too far, encouraged by extraordinarily loose financial conditions. It's now figuring out the right price to place on profits juiced and front-loaded by tax cuts in a world where Main Street might take more of the rewards of a humming economy than Wall Street.
A slightly less perfect setup, perhaps. But for now, it appears to mean this bull market is not broken, just bent.