The S&P 500 has declined 10% from its late July highs to the close on October 27th. Historically, the stock market averages slightly more than one 10% pullback every year, so this should not be a big surprise to investors. Indeed, we were skeptical of the summer rally and continued to advocate a slightly defensive posture during the advance.
Will this decline continue, or is it time to get more aggressive? Frustratingly, our answer lies somewhere in the middle. Shorter term indicators suggest the market is due for a rally soon. But the bigger picture items that have kept us cautious all year – money supply shrinking, narrow participation within the market, etc. – have not changed and need more time to play out, in our view. We must not become impatient in the face of a sideways moving market. When the market rallies we can’t get overly excited, and we can’t get overly negative during the pullbacks.
We think investors need to remain mostly invested as there are opportunities in individual stocks. To date, those opportunities have mostly been in the technology sector. It would be normal for market leadership to rotate to currently unloved sectors in the coming quarters. Nearly 2 years have passed since the S&P 500 peaked, and nearly 2/3rds of NYSE stocks are down more than 20% from their highs according to data from Ned Davis Research. The market has absorbed and priced in a lot of bad news to this point. But until our indicators give us a clear signal, we suggest continued caution. Our investment process will continue to rely on objective indicators to help tilt portfolios towards the small list of sectors and companies that have been most resilient this year. We continue to hold elevated cash and bond positions as we wait for signals to dictate our next portfolio actions.
