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With stock markets tumbling in October it is a great time to step back, evaluate the economy, and determine if this market correction is the start of the next big stock bear market. More likely than not this is the same run-of-the-mill correction we’ve seen four times in the last three years. But, as we move further along in this economic expansion, every decline deserves close attention. Needing no additional emphasis, it’s also never fun to see account values decline, even if only on a temporary basis.
As a reminder, market corrections of 10-20% are completely normal. On average they happen once per year. These corrections are usually based on a change in confidence, not a fundamental change in the economy. Confidence-based declines are worth paying attention to, but rarely require any action. More severe declines, based on fundamental changes to the economy, deserve much more attention and possibly action. As such, during declines like this it is important that we fully understand the economic backdrop.
Allegiant’s Economic Dashboard remains green across the board, signifying the economy is in good shape. However, these indicators do not reflect recent trends up or down, so this doesn’t necessarily mean everything is perfectly rosy. Below the surface there is a lot more happening - two of the six indicators are actually close to turning yellow. The year-over-year change in consumer confidence flirted with it a few months ago and has temporarily stabilized. However, it could easily roll back over. This indicator would turn yellow if the year-over-year change turned negative. (As a reminder, the indicators are green for a positive number, yellow for an average or cautionary number, and red for a negative number).
The second indicator on the cusp of warning is the S&P 500 versus its 20-month moving average. In fact, it did arguably turn yellow for a very brief moment this past month. As an indicator, we start paying attention when it crosses below the 10-month moving average and we really get concerned when it crosses below the 20-month moving average. This is the only market-based indicator on our Dashboard and it could quickly go from green to red, skipping yellow altogether.
Either one would mark the first yellow indicator since we started sharing the Economic Dashboard. However, it is not something to get overly concerned about. In fact, it’s not until three red indicators that we start ringing the bell for a possible incipient recession. False alarms can happen at any time, but historically three red indicators have been the best predictor of when we need to pay much closer attention.
How should one interpret this information? Market declines over the past six weeks were nerve-wracking for some. However, stepping back and looking at the economy, the nine-year bull market does not display signs normally associated with its imminent demise. However, now is certainly time to be extra vigilant. It is time to prepare the portfolios, and our own emotions, for the next recession and bear market. But, getting ready does not mean the stars have as yet aligned for the next recession.
Benjamin W. Jones, CFP®, AIF®
CERTIFIED FINANCIAL PLANNER™
Chief Investment Officer, Principal
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