Corrections Call for Calm

Stay cool.

Yes, stocks’ decline that started July 31 has now extended nearly to Halloween.

Yes, those declines are presently flirting with officially becoming a correction—a short, sharp, mostly sentiment-driven down move of around -10% to -20% from a prior high—true for both the S&P 500 and MSCI World Index.

Yes, this comes before stocks regained pre-2022 highs, and as that awful year still stings many investors.

And yes, we realize scary headlines are splashed across most outlets—chiefly citing perceived negatives from the Israel conflict to 10-year Treasury yields reaching 5% in a swift rise this autumn. Nonetheless, our counsel remains: Stay cool. Despite the recent market swings, fundamental factors look little changed to us. We aren’t aware of anyone who can reliably time corrections and sentiment-driven swings. They don’t call for action, in our view. They call for calm.

There is little doubt recent market action has been difficult for many. Since July 31’s highs, global and US stocks entered Thursday down -9.2% and -8.4%, respectively.^[i] (Exhibit 1) Markets are lower Thursday morning Pacific Daylight Time as we type, too.

Exhibit 1: Market Action Since Pre-2022 Bear Market High

Source: FactSet, as of 10/26/2023. MSCI World Index with net dividends and S&P 500 total return, 12/31/2021 – 10/25/2023.

Sharp market moves like this can be trying. But as we have noted before, declines of greater than -8% are common in bull markets. Corrections, too. During 2009 – 2020’s bull market, history’s longest, we count nine S&P 500 declines exceeding that mark.^[ii] The MSCI World had 10, adding one in September 2014 to the tally.^[iii] All had scary stories associated with them: Then-derelict Greece’s deficit debacle in 2010; the broader eurozone debt crisis and regional recession; America’s 2011 debt-ceiling fight and subsequent credit-rating downgrade along with double-dip recession worries; China’s 2015 “devaluation.” Those are merely a curated selection. We could go on. One of those started less than a year into the bull market. While the 2002 – 2007 bull market had fewer corrections overall, it packed one early on in March 2003 as investors fretted the Iraq War’s implications.

The big fears today have some echoes to those, but there are differences. Most notably: interest rates. Over the last 10 days, an ocean of headlines have pondered the implications of 10-year US Treasury yields nearing 5% for the first time since July 2007—over 16 years ago. That is a long time and, since it was also the financial crisis’s eve, many see this as “high” rates destined to “break” something. Many in media point to bank issues then and even earlier, despite the fact we aren’t aware of anyone who really thinks the 5% 10-year Treasury yield caused the financial crisis. The occurrence was coincident.

Exhibit 2: A Long Time Since 5% 10-Year Rates

Source: FactSet, as of 10/26/2023. 10-Year US Constant Maturity Yield, 10/25/2003 – 10/25/2023.

Still others say those 5% yields are a hurdle for stocks. That may be true of some companies or industries. But it doesn’t hold historically at a broad level. Zoom out past the last two decades and you will see this.

Exhibit 3: … But 5% Is Common Historically

Source: FactSet, as of 10/26/2023. 10-year Treasury Constant Maturity Yield, 1/2/1962 (inception) – 10/25/2023.

Yields have topped 5% on more than half the trading days since daily 10-year constant maturity yield data start in 1962. They were above the mark for the entirety of the period June 14, 1967, through September 8, 1998. Over that span, US stocks merely rose a paltry 3,035.1%, cycling through several bull and bear markets, as well as myriad corrections and pullbacks.^[iv] Interest rates weren’t much help in identifying the shifts. At a more granular level, rates were above 5% throughout the 1980s and most of the 1990s. Those were go-go periods overall for US stocks and the economy.

So there isn’t anything about a 5% 10-year rate that looks auto-problematic for stocks. Now, the speed of the recent rise may stoke uncertainty to an extent, as market volatility often does. But we don’t advise overthinking it. The general notion that “something” might break from rates’ rise, so common among pundits now, isn’t an investment thesis. It is a feeling … a fear … a guess, subject to all the biases that come amid volatility. Perhaps those rate fears and uncertainty are weighing on stocks for the time being. But we doubt it lasts.

The same could be said for Israel. As we noted recently, Hamas’s attack on Israel is an epic tragedy at a human level. But for markets, we don’t see it as a huge event. Most of the chatter around this is fear conflict could spread and interrupt important oil markets in the Middle East. But look at oil markets: Brent crude, the global benchmark price, is up just 2.6% from pre-attack levels and 8.9% year-to-date.^[v] Those aren’t huge spikes—nor are present high-$80s to low-$90s prices per barrel alarming levels. We suspect the conflict is weighing on stocks over the past few weeks, but largely due to uncertainty over how Israel will respond and any downstream impacts. In our view, there is little sign today the Israeli response or regional blowback will be sufficient to interrupt global commerce materially. That is key for coldhearted stocks, which chiefly weigh events’ impact on expected earnings over the next 3 – 30 months.

The irony of this recent market move is it comes as data continue to confirm global economic resiliency. Just today, US Q3 GDP posted strong results, largely underpinned by healthy consumer spending. Earlier this week, preliminary October purchasing managers’ index data from S&P Global showed both US manufacturing and services were above 50—in expansion.^[vi] Inflation is overall slowing globally. Chinese GDP, released last week, showed 4.9% y/y growth despite property market woes, suggesting the world’s second-largest economy isn’t tanking as so many fear.^[vii] Meanwhile, politics in the US look gridlocked. Even with a new House Speaker now in place, we wouldn’t expect divisive legislation to start flowing through Congress. The absence of big bills—which normally create winners and losers, roiling sentiment—is a plus for stocks, in our view. But also, having a speaker is step one in avoiding a government shutdown. We don’t think shutdowns are meaningful for stocks, but some fear it nonetheless.

To us, this downturn has the hallmarks of an early bull market correction. Potentially jarring, yes. Unpleasant, too. But short-term, emotion-driven volatility like this is normal in even the best bull markets. Trying to time the swings is exceptionally risky if you need equity-like, long-term returns to finance your goals. We realize it can be challenging, but this is a time to be cool, calm and collected.