September 15, 2021
Wow, I just got back from my first in person conference in over two years. I attended the National Association of Plan Advisors National Summit in Las Vegas, where I am part of the leadership council. This position is an honor, and I was nominated by my peers where, over the next three years, I will advocate for 401(k) Plan Sponsors and Plan Participants to our legislators in Washington D.C. I will keep you informed of the many changes in the retirement plan industry that are currently being proposed in the U.S. House and Senate. You might not know, but only 50 percent of the businesses in the United States have a 401(k)/403(b) plan. A major part of the retirement crisis in the U.S. is the lack of access for potential participants. Once you break down the demographics, it’s much more difficult for people of color to have access. You can expect that Congress will make a major push for access, and they already have a proposal on the table that potentially could add 62 million participants and $7 trillion in assets to the retirement system over the next 10 years.
On a lighter note, my time in Las Vegas opened my eyes to what can only be described as a football coma. While living my entire life on the East Coast, I wondered what it would be like to watch football on a weekend on the West Coast. The five states that make up the Pacific Time Zone contain 55 million people, or about 14 percent of the U.S. population. This small group starts watching college football as early as 8am on Saturday, but if they want to watch ESPN’s College Game Day, they have to be up by 6am. On Sunday, the NFL starts at 10am and ends after 9pm. Even better is Monday
Night Football, which starts at 5:15pm. How does anyone even tailgate? My hotel was across the street from the new Allegiant Stadium, and it’s the first time the Las Vegas Raiders have played in their new stadium in front of fans. Also, if you didn’t know, you can bet on almost anything in Vegas related to football, such has how long it will take to sing The National Anthem. With this crazy schedule, how does anyone get anything done on a weekend? Maybe this why the September stock market tends to be weak and how I can place the blame on those on the Left Coast. See ya soon.
Three Market Drivers
Here at Chairvolotti Financial, we focus on three market drivers that lead to notable movements in the stock market: market economic fundamentals, technical environment, and investor sentiment.
Our fundamental indicator follows 19 points economic data points that track the underlying health of the US economy. From unemployment to home building, changes in these economic data points tend to confirm recession or recovery after the technical and sentiment indicators have already reversed.
Dynamic Asset Level Investing, or D.A.L.I., is a technical indicator that compares each of the major asset classes, sectors, and sizes and styles against each other to discover emerging trends in the market. D.A.L.I. compares daily price action of each of these elements on a point-and-figure chart to illustrate momentum. The chart at the bottom of this page shows the current leadership in D.A.L.I.
Our sentiment indicator tracks how everyday investors currently feel towards the US economy and the stock market. Between Chairvolotti Financial’s own polling and professional surveys like the American Association of Individual Investors (AAII) Investment Sentiment Survey and Citigroup’s Panic/Euphoria Model, Chairvolotti Financial tracks the two most dangerous emotions for investors: fear and greed.
Here is a breakdown of where each market driver currently sits:
The Logistics Managers’ Index, or LMI, remains at an elevated level of 73.8 out of 100. Inventory costs, warehousing costs, and transportation costs all remain at or near the index’s all-time high.
The major market indices have shown increasingly narrow breadth, with nearly half of the stocks in the S&P 500 at least 10% off their 52-week high, as well as 80% of stocks in the Russell 2000.
The AAII Investor Sentiment Survey found nearly 73% of investors feel the stock market will be bullish or neutral in the next six months, an elevated level for this contrarian indicator.
A History of Market Corrections
With the market entering the historically weak and uncertain months of September and October, respectively, we think it is worth revisiting the history of market corrections. In the same way a car’s engine can overheat, the stock market can overheat after periods of sustained and, more often than not, rapid growth. At the peak of these growth periods, stocks prices may have even increased faster than their actual underlying value. In these instances, the stock market typically enters a market correction. To put it simply, a market correction is a temporary resetting of market prices. Market corrections typically involve the market falling at least 10%, but it can even fall as much as 20%. While no investor wants to see their account down 10%, market corrections help to ensure our stock market is at a healthy level and valuation.
While certain asset classes and sectors of the economy can go through isolated corrections, a market correction tends to affect all areas of the market at once. Once the market has seen a broad pullback amongst the sectors of the economy, stocks will once again continue their growth at their newfound prices.
Unfortunately, there is no crystal ball for predicting market corrections. However, we can look at history to create realistic expectations. In the table above, you will find the frequency of pull-backs in the S&P 500. You will notice that pullbacks in the market are frequent throughout history. In fact, the S&P 500 historically has a 10% or worse correction every 8 months on average! For perspective, the market has not had a correction of at least 10% since the end the crash last year, meaning that, if history is to be our guide, we have been overdue for a correction.
Finally, the burning question on everyone’s mind: what should I do? Due to the way 401(k) is structured, participants are uniquely capable of taking advantage of these draw downs. 401(k) contributions are made through a process called dollar-cost averaging, a phenomenon we covered last week. To recap, dollar-cost averaging simply means investing a consistent dollar amount on a scheduled basis. Dollar-cost averaging helps investors to avoid the two dangerous emotions of investing: greed and fear. Through dollar-cost averaging, 401(k) participants can consistently buy shares of their investments at the new, cheaper prices set during a correction. Once these shares increase in value during the correction’s recovery, you will own even more of
these shares, taking advantage of the eventual rebound.
While it is much easier said than done to stay the course during a correction, it is important to remember that we are long-term investors for retirement. Our best advice is to remain calm, continue to contribute, and stay informed. While we cannot know for certain what size this pullback will be, we know that history shows us that corrections are a natural, healthy, and relatively frequent occurrence in our markets.
Market Indices Year-to-Date
LARGE CAP INDICES
S&P 500: 18.29%
Dow Jones Industrial Average: 12.97%
MID AND SMALL CAP INDICES
S&P 400 (Mid Cap): 15.89%
S&P 600: (Small Cap): 17.90%
Russell 2000: 11.91%
MSCI EAFE Developed Index: 11.30%
MSCI Emerging Markets: 0.38%
MSCI ACWI ex-US: 8.30%
ECONOMIC SECTOR INDICES
Basic Materials: 13.99%
Communication Services: 27.05%
Consumer Discretionary: 12.02%
Consumer Staples: 6.50%
Real Estate: 28.53%
Breadth: A Market Health Checkup
As a follow-up to the earlier article in this newsletter addressing market corrections, we also want to address a related financial term you may hear: breadth. While phrases such as “market corrections” typically are referring to a major market index like the S&P 500 or the Dow Jones Industrial Average, breadth is more concerned with what is actually happening under the hood of these indices.
When you hear the term “market breadth,” the best way to think about it is to view it as a measure of the number of stocks actively participating in the index’s performance. For example, when market breadth is high, this means that many stocks are contributing to the index’s performance; we would consider this a healthy market environment. On the flip side, a market that is rising but has fewer and fewer stocks participating in the index’s performance is considered a narrow (or top heavy) market. When an index is narrow and only a handful of stocks are keeping the index afloat, this is considered an unhealthy market that has the potential to be vulnerable to additional drawdowns.
Now, the reason that we bring up market breadth is that we are currently experiencing a narrow market breadth environment. From a “market correction” standpoint, we are far from the typical correction benchmark of at least a 10% decline. However, our market’s current breadth tells a different story. As of yesterday’s close, the S&P 500 currently sits a little over 2% below its 52-week high. However, roughly 46% of stocks in the S&P 500 are already at least 10% below their 52-week highs, meaning that roughly half of the stocks inside the index are already experiencing corrections.
From a small cap perspective, the breadth weakness is even more apparent. As of yesterday’s close, the Russell 2000 index, an index of small cap U.S. stocks, was roughly 6% off its 52-week high. In contrast, over 80% of the stocks in the Russell 2000 are already in the middle of a correction, indicating increased weakness in smaller stocks.
Historically, larger blue-chip companies have a tendency to participate in broad market pullbacks later than smaller companies; one could assume it is because they are viewed as a “safe haven” compared to the riskier, small cap companies. However, this would not be the first time that we have seen pockets of the market experience a correction while the broad market indices do not. For example, earlier this year the Nasdaq-100 experienced a correction in March, with growth stocks and technology stocks in particular being hit the hardest. The S&P 500, however, was only down about 4% during the same timeframe.
It’s too early to know whether this underlying weakness in market breadth is the precursor to the “correction” that has been overdue, and if the mega cap names will eventually join the pullback. Likewise, as we mentioned in our previous article, corrections are a healthy and vital aspect to investing in the stock market. While it may be impossible to predict corrections, being aware of the market’s current breadth is a convenient way to remain informed about the market’s underlying health.