Strange as it may sound, a growing number of investors and traders are actually hoping for a stock market correction of 10% or more, the Wall Street Journal reports. Those eager to see a correction say that it would lower speculation, deflate pockets of froth in popular investments and provide buying opportunities for investors watching from the sidelines, the Journal says.
There have been only four corrections during the current 8-year bull market, during which time the S&P 500 Index (SPX) has more than tripled. By comparison, since the late 1980s the market typically has experienced an average of one correction per year, according to analysis by the Journal. Cautious investors and contrarians find long periods of largely unchecked advances to be a worrying sign, perhaps an indicator of irrational exuberance that has become untethered from economic fundamentals. (For more, see also: The Single Number Preventing a Trump Bull Market.)
Short and Sharp
About half of the market corrections since 1989 were neither part of a longer bear market period nor the result of a general economic recession, according to analysis by global institutional brokerage and advisory firm Strategas cited by the Journal. On average, this subset of corrections lasted 2.4 months, bottomed out at a 14.2% decline, and was followed by a 16.5% gain over the ensuing three months. Those investors who welcome a correction now are betting on a similarly quick dose of medicine followed by a rebound.
Signs of Overvaluation
While analysts still expect S&P 500 earnings to grow in the first quarter versus the same period of 2016, their forecasts are becoming more conservative. Analysts have shaved their first-quarter earnings growth forecasts to 9.1% today from 12.5% in December, per FactSet data cited by the Journal. Valuations also remain high. Last week the S&P 500 sported a price-earnings ratio (P/E) of 21.5, based on earnings for the prior twelve months, whereas the average ratio for the previous ten years was 16.5, also according to FactSet data reported by the Journal.
Meanwhile, 34% of portfolio managers surveyed by the Merrill Lynch division of Bank of America Corp. (BAC) believe that equities are overvalued, per the Journal. This is the highest overvaluation reading given by this survey since the year 2000. As for investors who were banking on a big boost to corporate earnings from deep cuts in corporate tax rates promised by President Donald Trump and Republicans, the odds are growing that more modest reductions will be enacted, and with delays. (For more, see also: Investors May Have to Settle for "Tax Reform Lite.")
Impact of Interest Rates
Additionally, rising interest rates are making fixed-income investments a more attractive alternative to stocks. Bond funds attracted $7.8 billion of net new money in the week ending last Wednesday, while U.S. equity funds had net withdrawals of $8.9 billion, per data from EPFR Global cited by the Journal. Gold funds are also seeing growing inflows.
An immediate catalyst for a correction may be tightening by the Federal Reserve. Since 1987, the Fed has increased interest rates five times in quarters during which GDP growth was 1.2% or less, and each time stocks fell by 3% to 12% during the following three months, per research by UBS Group Inc. (UBS) reported by the Journal. The Fed raised rates at its most recent meeting, and the Federal Reserve Bank of Atlanta is forecasting 1% GDP growth for the first quarter, according to the Journal. (For more, see also: The Fed, Wall Street, Economists Love Rate Hikes.)