corrections - cause and opportunity - Janney Montgomery Scott LLC

August 7, 2017

CORRECTIONS - CAUSE AND OPPORTUNITY Gregory M. Drahuschak

With only several brief interruptions since the 2009 stock market low at 666.79, the S&P 500 has been on a strongly upward trajectory. Investors, however, worry that the duration of this market upturn may assure a pullback or correction. Since WWII, there have been 56 market pullbacks of 5% to 9.9% and 21 corrections of 10% to 19.9%. On average, pullbacks have occurred every year while corrections have happened every 2.8 years. It has been 17 months since the stock market had at least a 5% pullback. A 5% pullback may be welcome and perceived as largely inconsequential. It would be nothing more worrisome than a $25 stock slipping to $23.75. The bigger concern for some investors is a correction. Stock market corrections are rooted in one or a combination of several conditions: 1. Excessive valuation - When the earnings multiple (P/E) for a stock or market index vastly exceeds historic norms, a reversion to the mean is possible. 2. Rapidly rising interest rates - Rate increases decrease the value of future cash flows. Interest rate change that results in an inverted yield curve often is a major catalyst for a market correction 3. Falling earnings growth – Even if corporate earnings continue rising, a slower rate of increase than had been expected can produce an adverse market reaction. 4. Excessively positive sentiment – When the vast majority of investors exhibit no market concern, a reversal in sentiment can shove stocks down. 5. A recession – The close tie between GDP growth and the equity market makes a recession the most negative factor that could send stocks lower. 6. External factors –A geopolitical event or sudden adverse happenings overseas can send stocks lower 7. Technical conditions – Internal market factors can reach extremes that lead to a downturn. 8. Complacency – Often coincident with excessively positive sentiment, the willingness to overlook concerns can presage a market reversal. The VIX Index often is used as a proxy for complacency. A negative and unexpected geopolitical event can prompt a sudden market drop, but most often, corrections evolve slowly and require the existence of two or more of the conditions mentioned above. As such, tracking changes in each of the conditions can provide guidance about the possibility of a pullback or correction. Among the eight conditions that could precipitate a correction, at this time some technical factors hint of a temporary market slide but one that most likely would be relatively shallow and short-lived. The likelihood of a recession in the next 12 months is very low. Valuation is elevated but as long as earnings growth remains strong, valuation on its own is unlikely to motivate a downturn. It should be noted that time was not in the list of conditions that could lead to a correction. Instinctively, it might appear that the longer market goes without a major correction the more likely one is due. This premise simply does not stand up when you examine market patterns over many decades. What you do if the market endures a correction is more important than worrying about one. However, the market on average does not provide much time to react.

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The 56 pullbacks since 1945 produced an average 7% drop, taking about one month to go from peak to trough. However, the S&P 500 took an average of only two months to recover the loss. The market took only about four months to recover fully from 10%-to-19.9% declines. In more than 85% of all post-1945 market declines of 5% or more, the market recovered the pullback or correction loss in an average of four months or less. Monitoring the eight correction indicators can help to prepare equity investors for an opportunity to increase equity exposure, or stay the course; not panic out of solid long-term holdings. Disclaimer: Past performance is no guarantee of future performance and future returns are not guaranteed. There are risks associated with investing in stocks such as a loss of original capital or a decrease in the value of your investment. This report is provided for informational purposes only and shall in no event be construed as an offer to sell or a solicitation of an offer to buy any securities. The information described herein is taken from sources which we believe to be reliable, but the accuracy and completeness of such information is not guaranteed by us. The opinions expressed herein may be given only such weight as opinions warrant. This Firm, its officers, directors, employees, or members of their families may have positions in the securities mentioned and may make purchases or sales of such securities from time to time in the open market or otherwise and may sell to or buy from customers such securities on a principal basis.

WWW.JANNEY.COM © JANNEY MONTGOMERY SCOTT LLC MEMBER: NYSE, FINRA, SIPC

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