Is the U.S. market due for a correction?

Is the U.S. stock market poised for a correction? Is January’s decline of 4% the start of a bigger correction?

These are perfectly understandable questions. In fact, we hear them repeatedly when meeting with our clients here at Newport Private Wealth. And they are being heavily debated within our Investment Committee and by investment experts whose opinions we value. After all, the S&P 500 has increased by almost 50% in the last two years including 30% in 2013.

The pessimists are arguing that:

  • the S&P 500 has increased for five consecutive years and a six-year streak has only happened once before (1982-89); and
  • market returns after two consecutive years of double digit returns have typically been modest; and
  • the stock market is expensive at 16x earnings.

(Source: BMO Nesbitt)

The optimists have compelling points to make as well. They argue that:

  • stock markets can and have traded well above the current P/E multiple when inflation is under 2%. (inflation is currently less than 1%); and
  • private investors remain very “under-invested” in the stock market. They withdrew $451 billion from 2006-12 and only reinvested $60 billion last year.

This is a very common dilemma in the life of an investment manager such as Newport Private Wealth. We are repeatedly faced with conflicting facts and viewpoints, most of which are persuasive and compelling on some level.

Will there be a correction in 2014? We think it’s likely. But corrections are a normal part of the investment cycle and they are often part of a long-term bull market. In fact, corrections are seen by many as a healthy part of the journey. They even provide an opening for those investors who are late to the game to get invested.

Take a quick look at the chart below. The S&P 500 has doubled in the last five years and there have been four pullbacks along the way, including one correction of almost 20%.

large decline Jan20141 Is the U.S. market due for a correction?(Source: WSJ Data Group)

The more important question, in our view, is “are U.S. stocks a good place to make money over the next three or more years?”  We have confidence in our positive view of this question. But we would not be surprised to see one or more corrections along the way.

However, we do feel that different strategies are in order at this point in the cycle. From our perspective, further gains in the U.S. market will have to be driven more by earnings growth rather than a broad-based market rise. Therefore, we believe that the right approach is to be more selective by way of prudent “stock-picking” as opposed to just owning “the market”. Lastly, we are currently holding healthy cash balances in our equity funds with the hope that we will be able to put the money to work at more attractive prices.

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