A couple of weeks ago I wrote, “If this selloff turns into a 10% decline, it would be the second such correction within eight months, which I fear would mean this nearly decade-old bull market is really in trouble.”
My reasoning: This was such a rare event (over the past 30 years it has happened only once, and never after a long bull run) that I could no longer assume the stock market would come roaring back.
Monday’s wild swings in share prices ultimately drove the Dow Jones Industrial Average DJIA, -0.99% to an 8.9% decline from its early October all-time closing high and the S&P 500 SPX, -0.66% to a 9.9% drop from its Sept. 20 peak. The Nasdaq Composite Index COMP, -1.63% and the small-cap Russell 2000 RUT, -0.44% off 13.1% and 15.1%, respectively, from their late August peaks, are comfortably within correction territory.
What bothers me most is that some of the previous biggest gainers are trailing badly, while economically sensitive sectors have sold off dramatically, and bellwether home builders’ stocks are already deep in a bear market.
This selloff comes as GDP growth is strong and earnings are so far registering their third consecutive quarter of above-20% annual growth. That could mean all the good news from the 2017 tax cuts already is in the price of stocks, leaving investors searching for a new catalyst to drive the market higher.
Let’s start with the leaders that have become laggards. Since hitting their all-time highs earlier this year, Facebook’s shares FB, -2.26% and fellow FAANG Netflix NFLX, -5.00% have plummeted about one-third from their peaks. Google parent Alphabet GOOG, -4.80% GOOGL, -4.52% and Amazon AMZN, -6.33% which have plummeted 20% and 25%, respectively, from their peaks, have also crossed the bear-market threshold, widely defined as down 20% or more from a recent high. Among the FAANGs, only Apple AAPL, -1.88% which has sustained a 8.5% decline from its all-time high, has not yet moved into even correction territory.
The FAANGs’ comeuppance was long overdue. What’s more disturbing is the huge decline in economically sensitive sectors. At Monday’s close, the SPDR S&P Homebuilders ETF XHB, -1.26% was down more than 30% from its January all-time high. Home builders never recovered from the early 2018 correction and kept falling instead of rebounding to new all-time highs.
Read: As the housing market stagnates, American homeowners are staying put for the longest stretches ever
Other cyclical stocks have been pummeled. The S&P 500 Airlines index SP500-203020, -0.70% has fallen 19% since its early January peak, and the bellwether Dow Jones Transportation Average DJT, -0.70% is off 14.5%. The S&P 500 Automobiles & Components Industry Group Total Return index SP500-2510TR, +2.61% lost one-third of its value before a little bounce last week.
Sectors that historically have done well later in a recovery also have sold off big from the all-time highs hit earlier this year. The Materials Select Sector SPDR ETF XLB, -0.24% is down around 20% from its all-time high, while the Industrial Select Sector SPDR XLI, -1.66% is off by about 14%. Even the Financial Select Sector SPDR ETF XLF, +0.87% which is supposed to benefit from rising interest rates, has lost 15% of its value from its 2018 peak.
So, if technology is lagging, economically sensitive sectors are in or near bear markets, and late-cycle sectors are also reeling, where will the leadership for the next move up come from? Consumer staples? Utilities? Get the picture?
This all comes as the economy is growing strongly and unemployment is at 3.7%, nearly a 50-year low. I’ve written here before that a cyclically low unemployment rate is often a harbinger of bear markets and recessions. You can never say for sure that the current unemployment rate is going to be THE lowest, but how much better can things get?
Indeed, the latest GDP report may show that the economy has peaked. Growth was a robust annual 3.5% in the third quarter, the Commerce Department reported, but that was down from the second quarter’s 4.2%.
But business investment—the entire false rationale for last year’s tax cuts for the rich and big corporations—rose by only 0.8 percentage points. And poor trade numbers may have cut GDP growth by 1.78 percentage points, trade’s largest negative contribution to GDP growth in 33 years. Sorry, Trumpkins, but the tax cuts aren’t delivering as advertised and the president’s trade wars are shooting the economy in the foot.
Read: Slump in capital spending hints that corporate tax cut is fizzling
Which brings us to earnings and interest rates. Although nearly half of S&P 500 companies have reported, and 77% of them have topped Wall Street’s earnings estimates, according to FactSet Research, stocks are selling off. Clearly, investors already are asking what will you do for me next year? As the Federal Reserve continues to raise short-term interest rates and as yields on 10-year Treasury notes TMUBMUSD10Y, +0.89% have settled above 3% and look poised to move higher, investors are faced with rising rates and lower earnings growth next year. No wonder they’ve been selling.
We’ll probably see some strong rebounds, but stocks have big hurdles to climb before they give investors the “all-clear” signal. I don’t know if we’ll have another recession and bear market or if stocks will just post lower returns over the next decade, but something fundamental has changed and I’m worried.
Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold.
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