Just before Christmas we wrote a commentary suggesting that the easy low volatility investing might be coming to an end after more than a year of the broad equity indices moving up without a correction of more than 5%. Not only is such an unabated move up highly unusual, but it is not particularly healthy either (in my opinion). I suggested then that despite a probable bounce from oversold conditions, markets appeared over the coming weeks to be headed for a test of support levels formed during the spring and summer. These levels coincide with the Dow, S&P 500 and Nasdaq’s 200-day moving average – and where the rubber meets the road between bull and bear markets.
Well, we got the bounce and then a big-time resumption of December’s pullback. As of yesterday, in the span of the four market days, the benchmark S&P 500 had dropped more than 3% percent and the Nasdaq dropped a whopping 5%. The Nasdaq now officially entered correction territory with a 10% fall from November highs. The reasons given are that inflation is running rampant, the Fed will be forced to raise interest rates, the Omicron variant is decimating the United States and the sky is falling (according to chicken little!). Like all things bantered about, I believe there is some truth to be found in all of this… other than the sky falling part. Yes, inflation is running hot, the Fed is going to take off the training wheels and begin to normalize monetary policy, and Omicron is spreading like wildfire around the country. Now for the rest of the story as I see it…
We have inflation because people want to buy things and we don’t have enough of those things. The reason there is not enough is due to supply chain disruption (which is by all accounts temporary) and the simple fact that the world is moving forward and growing. Interest rates are rising because the economy is getting healthy. Unemployment is falling and wages are climbing. Rising interest rates are evidence of underlying economic strength, not weakness. Omicron is all over the place, but the idea that COVID is going to shut down anything is long gone. People certainly seem finished with putting their lives on hold. If you don’t believe me, look at the numbers of people who flew on airplanes this holiday season. More than the number that flew in 2019, and that is accounting for all the flights canceled this year.
Ok, enough of that. Back to the correction we are seeing. Corrections can be healthy because they coincide with money moving from overbought sectors to other out-of-favor sectors. This is often how new technologies and industries are developed in the first place. The money that supports those new companies’ growth and innovation has to come from somewhere. It often comes from money leaving another investment. It is a zero-sum game, folks. This week we have seen a big rotation out of technology and into beaten down areas of the market, like industrials, financials, and even good old staples. Isn’t that a good thing? Shouldn’t those areas be afforded some investment dollars to innovate and improve their businesses? They create jobs and add value to our society just like Amazon and Apple and Netflix. Does that mean that Amazon and Apple and Netflix are any less important or viable? Of course not. It just means that investment dollars are being redeployed. It is this process that creates depth and strength in our economy. It is why the “stock market” has been higher for every rolling 20-year period since the inception of this country. It is the corrections that lead to our reinvestment in ourselves. Think of it like an NFL team. If all your money goes to the quarterback and middle linebacker (even if it is Tom Brady or Drew Brees) and nothing is left to hire talent at the other twenty positions plus kickers, your team is eventually going to fail. The quarterback needs somebody to throw to. He needs a running back to keep the defense honest. He needs a left tackle to protect him. The linebacker needs a solid secondary behind him and a defensive line in front of him. Think of a market correction as being the GM of the team, taking some money from the quarterback and linebacker and using it to hire some of the other important positions. Guess what happens then? The team gets stronger and sometimes wins a Super Bowl. Then what? The whole team gets a raise. That is why corrections are good and the stock market generally goes up over time.