Monday, August 15, 2011

Markets Update – Stock Market Corrections

A stock market correction is generally defined as a 10% drawdown from a recent high. Researching the market indicated that these corrections occur about once a year on average, which is rather common. Unfortunately, long term investors are forced to accept these corrections as the timing and degree are uncertain.

Each time we enter a stock market correction, investors – and advisors – consider whether this correction is likely to lead to an all-out bear market or if it’s leading up to a negative economic event. Only about 25-30% of market corrections lead to deeper market declines of 20% or more – commonly referred to as bear markets. Interestingly, bear markets, which occur every three to four years, happen slightly more frequently than recessions, which have historically occurred about once every five years.

In the summer of 2010 we saw a 16% correction, about equal in degree to what we have witnessed in 2011, although a bit less dramatic than the recent market action. We believe that what we’re experiencing now is more similar to 2010 than 2008. So far, we believe this year’s correction is likely to remain just that – a correction.

Several data points lead us to believe the market and the economy are likely to recover in the months ahead. First, employment trends have held rather steady and, if anything, show a slightly positive trajectory. The recent weekly unemployment filings have come in roughly in the 400,000 range, while last summer the weekly average filing new unemployment claims averaged closer to 450,000 per week. As a reference point, even during healthy economic periods there are typically around 300,000 who file unemployment claims on a weekly basis. In addition, the current unemployment rate is 9.1% versus 9.5% readings a year ago. These numbers are not indicative of robust economic growth, but are certainly not indicating a negative economic turn, either.

Another item we found reassuring last week was the uptick in insiders buying their own company stock. Insiders are not always right nor do they always display perfect timing in their purchases, but it’s reassuring to see many who have intimate knowledge of their businesses who believe the market has priced those businesses at a good value. Some of the companies cited in various reports with insider purchases included Morgan Stanley, General Motors, Kraft, Chesapeake Energy and JP Morgan Chase. Barron’s reported that this spree of insider buying was coming in at the fastest pace since March of 2009.

These are just some of the economic metrics we are watching as we try to make sense of very volatile markets. We believe a rebound is likely for equity prices in the months ahead, but will be watching closely and staying nimble as conditions can change quickly.

Eddie Wilcox
Partner and Financial Adviser, Rollins Financial, Inc.

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