A correction of more than 10% on the S&P 500 this year is not only possible, it’s probable. I believe a decline in the market could create a buying opportunity for equity investors. With a small 6% pullback in March, we have yet to see an intra-year correction which usually occurs.
WrapManager’s Investment Policy Committee believes these next few weeks or months could produce some excellent buying opportunities and equity investors may want to be ready when they arrive.
Corrections Are Normal
Take a look at the following chart. The bars represent the annual return of each year and the small dot represents the intra-year drop for each particular year. Click on the image for the larger version with data to 2010.
Source: S&P, Factset, JP Morgan Asset Management.
Intra-year drops refers to the largest market drops over periods of 6 months or less. For illustrative purposes only. Data are as of 3/31/2011.
Over the last 31 years, the S&P500 has experienced an average intra-year drop of 14.3%, with every year down at least part of the time. However in 24 of those 31 years (~77%) the market finishes the year with a positive return! Looking at 2009, we see the market was down 28% percent at one point, but finished the year up 23%. More recently during the first quarter of 2011, the S&P500 suffered a 6% sell-off but ended up 5.9%.
Expansion Slow, But Still Getting Started
We believe this is a bull market which will continue after a normal pull back. The average bear market decline is 35% on the S&P500 and usually lasts 14 months. However the average bull-run on the S&P500 is 176% and lasts an average of 68 months. Of those 68 months, it generally takes about 2.2 years to reach the previous bull market’s peak based on historical numbers.*
Lower mortgage rates help housing and a lower dollar helps exports, both of which I believe will start making a positive impact by the 3rd and 4th quarter this year. Looking at valuations, the S&P500 is at 13.1 times forward earnings (as of 3/31/2011). With an average of 16.5 over the last 20 years, any pull back makes stocks even more attractive.
Headwinds
The biggest headwind I see are overblown fears about the first major market correction since the run up in the SP500 that started in September 2010. The press will almost certainly play it as the coming of a double-dip. But remember corrections are a normal part of the market cycle.
The other major boogie man is the ongoing debt ceiling issue and associated political games. As we’ve seen time and time before, political maneuvering usually affects the market over the short-term as it creates uncertainty. Once these issues are resolved, the market should potentially get back to its fundamentals.
Hopefully we’ve all enjoyed the run up in the market over the last year or so. Corrections, while perhaps a bit difficult to handle on the psychological side, are part of normal markets. We know they occur and we know the media might come out and play on fears. We believe the coming correction could be a buying opportunity that you may not want to miss!
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*A bear market is defined as a peak-to-trough decline in the S&P 500 Index (price only) of 20% or more. The bull run data reflect the market expansion from the bear market low to the subsequent market peak. All returns are S&P 500 Index returns and do not include dividends. Data are as of 3/31/2011. Source: JP Morgan
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