Given the stock market’s 10% drop over about the past two weeks, the question we’re left with now is less about “why” and more about “what.” What to do from here?
First, we must keep in mind that the S&P 500 has appreciated by almost 30% in three years with little volatility and only minor corrections (if you can even call them that). In addition, risk assets such as stocks have risk embedded in them, which is why over time they deliver excess return.
With that perspective, we start with the Astor Economic Index® (AEI), our proprietary “now-casting” of the U.S. economy, which currently indicates that risk assets still have a positive expected return.
It’s also interesting to note that, since the March 2009 bottom of the Great Recession, the S&P 500 has had 3 corrections of more than 15%. Each of them occurred while the economy, as measured by the AEI, was expanding or was growing above trend. None of these downward moves caused wealth destruction, as losses were recouped before the end of the following quarter.
If we go back 40 years, we find that 20%-plus corrections that lasted 12 months or longer occurred during time periods when the U.S. economy was in contraction mode—except for 1987, which, by the way, was an up year and all losses were recovered by the end of the following year. The reason, in my opinion, was that the U.S. was not in a real recession in 1987—market disruption, to be sure, and slowing in financial economic activity and residential real estate. But GDP and the economy kept marching on. The cause was more of a technical trading-related “glitch.”
This brings us to today. Fair value is adjusting to a few new conditions, including higher interest rates, expectations for higher inflation, continued low unemployment and rising wages, and overall greater uncertainty. Add to that our previous discussion about the market mechanism in futures, (discounts and premiums to cash prices) resulting in substantially lower costs for hedges than in the recent past.
Markets don’t go up in a straight line, nor do they go down in a straight line. Wherever fair value ends up, the market likely will find it quickly. From that point, I believe the path for stocks is higher and the economic data still indicate that stocks have a positive expected return.
At Astor, our number one determinant in portfolio allocation is the state of the economy. We continue to watch the AEI and other economic indicators closely for any change in the economy. As of this writing, there is very little change to the economic data.
While we will be making slight changes in our portfolios for correlation and volatility, we do not expect to make significant changes to beta (exposure to risk assets) until the economy says so.
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The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.
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