Market Update

The S&P 500 fell 1.7% to 4458.58 last week. The index dropped all four trading days. It closed below its 20-day moving average Friday. The 50-day moving average sits at 4425. The 50-day has proved strong support since early March when the index spent a few days below it. Pullbacks have bounced at the 50-day moving average six times since. The market tried to bounce Friday morning but ran into selling. It was unable to break through 4500 around 1 p.m. and eventually headed lower. The index set the low for the day in the last 15 minutes of trading, a short-term negative. The S&P 500 looks set to test the 50-day moving average early in the week.

Corrections occur about once every 17 months, according to Dow Jones Market Data. A correction is a pullback in the market of at least 10%. Bear markets are pullbacks of at least 20% or more. Either a bear market or correction happen about once per year. We haven’t had a correction since the stock market bottomed in late March of 2020. We came close in September of 2020 but just missed on a closing basis. The average time to a correction coming out of a bear market is roughly 17 months, according to Barron's. It has been almost 18 months since the S&P bottomed in March of 2020. We are due for a correction, which does not necessarily mean we’ll have one in 2021. Corrections and bear markets need a catalyst, and the catalyst is missing so far. A Federal Reserve rate hike cycle is high on the list of possible catalysts.

Stifel strategist Barry Bannister predicted a “near-term” correction in a recent research report. He pointed to an autumn Covid resurgence in northern states as the catalyst, according to Barron’s. Lisa Shalett is the chief investment officer at Morgan Stanley Wealth Management. She is predicting a 10% to 15% drop in the S&P 500 before year’s end. She wrote in a note to clients that she does not consider herself bearish. Rather, she points out that most 12-month periods contain a significant pullback for the S&P 500. Falling forecasts for Q3 growth is another possible catalyst for a correction. Goldman Sachs joined the ranks of banks reducing their Q3 GDP growth forecasts. Goldman cut its forecast to 3.5% from 5.25%. Morgan Stanley, Oxford Economics, and the Atlanta Fed had all cut growth forecasts the week before last. Some strategists now have a year-end target for the S&P 500 below current levels. Bank of America has a target of 4250, about 5% below where the index is now.

Economic Update

It was a light week for economic data. Job openings rose to 10.9 million in July from 10.1 million the prior month. Businesses continue to struggle to find workers. A skills mismatch is partially to blame. A lack of childcare, enriched unemployment benefits, and fear of Covid are other likely causes. Initial jobless claims fell to 310,000 last week from 335,000 the week prior. The trend continues in the right direction.

Concentration risks your retirement portfolio

I sat with a participant in one of our 401(k) plans last week. She is 60 years old and hoping to retire at 67, along with her husband. The participant wanted my opinion on her current allocation. She had almost 90% of her money in the S&P 500 index. The rest was in a Vanguard Real Estate fund. Needless to say, she’s had a good run over the last few years. The S&P 500 is up 376% over the last decade, almost 17% per year. I don’t know if she’s had that allocation the entire time. Regardless, the S&P 500 has been the place to be for a while now.

I told her she needed to diversify her portfolio. I explained that the U.S. large-cap market is one of the most expensive markets in the world. I also told her the S&P is as expensive as it has ever been. Market Cap to GDP is known as one of Warren Buffet’s favorite indicators. Market Cap is currently 175% of GDP, a record. Bank of America is forecasting a loss for the S&P 500 for the next decade. The last time the bank’s indicators projected a negative 10-year return was 1999. Further, almost a quarter of S&P 500 value is in five stocks – Alphabet, Microsoft, Facebook, Apple, and Amazon.

She needs small and midcap exposure. Also, exposure to international and emerging markets. A position in short-term Treasuries would help as well. Her retirement timeline is at risk. People forget how bad a bear market can be. It is almost a certainty that we’ll have a recession in the next seven years. It is almost a certainty that we’ll have a bad bear market in the U.S. in that time. The 2000-2002 bear market lost around 50%. It wasn’t until the fall of 2007 that the S&P 500 returned to March 2000 levels. The 2007-2009 bear market cost the S&P 500 around 55%. It wasn’t until the summer of 2013 that the S&P 500 made it back to 2007 levels. The index gained exactly zero over that 13-year period.

She took notes. She didn’t seem convinced though. My prediction is she’ll let it ride for now. Most people think they can exit near the top. They don't want to miss out on the gains in the meantime. Almost no one can do it, but they still try. Her retirement date target is threatened unless she diversifies. I hope she does.

Regards,

Christopher R Norwood, CFA

Chief Market Strategist