Gravitas Ventures / courtesy Everett Collection
On the last trading day of 2017, the S&P 500 Index closed at 2,674 points.
Almost four months later, the benchmark index is grinding around the same level. So will 2018 be a lost year for investors?
Many investors are surprised, even disappointed, by the stock market’s funk of inactivity. But when viewed in context, the funk is absolutely normal, even expected.
From the February 2016 low (where I issued a buy signal) to the January 2018 high, the S&P 500 rallied 1,060 points, or 58%. The Dow Jones Industrial Average and Nasdaq did even better, and the VIX dropped to an all-time low.
Crevice turns into canyon
In the big picture, the decline from the all-time high is a crevice that’s been turned into a canyon.
The rally from the February 2016 low (and the 2009 low) overshot even my most optimistic upside target at S&P 500 2,829 (red horizontal line in chart, above).
The concept of mean reversion dictates that everything that goes up must come down. It’s important to keep in mind, though, that it doesn’t have to come down all the way down.
The market simply needs to digest its gains. Throughout history, periods of strongly rising prices have been followed by digestive periods, aka consolidation.
In the Feb. 11 Profit Radar Report, I said: “For well over a year, stocks have almost exclusively gone up, slowly but steadily. For the past two weeks, stocks have gone down quickly. What’s next? The temptation and trap is to think two dimensional — up or down — since that’s most of what we’ve experienced lately. However, stocks could also go sideways for a period of time.”
Correction or bear market?
Obviously, some corrections have turned into full-fledged bear markets (i.e., 2000 and 2007). Could that happen in 2018? Unlikely. Here’s why:
1. Seasonality: Historically, the S&P 500 declines, on average, 14% into its mid-election year (2018 in this case) low. From there it rallies, on average, 37% into the pre-election year (2019) high. (More details on S&P 500 seasonality pattern here.)
2. Liquidity: Money flow into stocks (as measured by my favorite liquidity) indicator is strong. Liquidity dried up prior to the 2000 and 2007 bear markets (red vertical boxes in chart, above).
Aside from a brief liquidity shortfall in 2015 (before two 10%-plus corrections), liquidity has been strong since the 2009 low.
Conclusion
There are two main takeaways for investors:
1. It’s normal for stocks to churn and digest strong prior gains.
2. Long-term indicators suggest that this correction will not turn into a bear market.
A more detailed short-term S&P 500 analysis is available here: “S&P 500 update — know what to expect.”
Simon Maierhofer is the founder of iSPYETF and publisher of the Profit Radar Report. He has appeared on CNBC and FOX News, and has been published in the Wall Street Journal, Barron’s, Forbes, Investors Business Daily and USA Today.