This week we have seen the markets take a tumble and many are concerned about a correction around the corner. Yesterday declining stocks swamped advancing issues by a 9 to 1 margin on the NYSE and 5 to 1 on the Nasdaq. Trading volume was higher than usual. Certainly trading days like this, remind all of us as long term investors, that stocks entail a certain amount of risk and corrections are inevitable.
In our stock and mutual fund models we made adjustments to get slightly more conservative and pared back on large company holdings, increasing our exposure to bonds and business development companies.
Are we due for a major crash, a recession or a temporary pullback?
Based upon past history, the markets tend to be particularly susceptible to panic and fear during mid-term elections. As the candidates and the media turn increasingly negative heading into November the emotional frenzy tends to spill over into the markets. It could be different this time. All of us may want to ask ourselves if our politicians have suddenly changed and are now above all of the negative mud-slinging that is typically rampant in the weeks heading toward election day.
We would say a correction is due, but are we in for something more?
Based upon what we see with regard to the U.S. Economy and the treasury yield curve, we are not overly concerned about seeing a protracted downturn. Valuations are toward the high side but have not reached the nosebleed area yet.
Whenever the short term treasury yield (1-3 years) exceeds the longer term yields (10 year and 30 year) we are typically in for trouble. As you can see from the chart below, we saw this happen in the late 80s, in 2000/2001 and again in 2007. Looking at this alone can give us a particularly good view of the state of the markets and the economy going forward.
Leading economic indicators also give us a good gauge as to what may happen in the future. A downturn in these indicators tells us that things may turn for the worse soon or within the next couple of years. These indicators are not as easily quantifiable and not quite as prophetic as the yield curve, but are helpful nonetheless.
In looking at these charts, it does not look like the sky is about to fall, however we could be in for rough waters fueled by a media frenzy that is typical in the weeks preceding Election day.
Data as of 7/25/14