The post-election surge in US stocks has lost its steam in March.
A big drop might be the best thing that can happen next.
That may sound counterintuitive.
After all, most investors — especially those piled into increasingly popular index funds — gain only when the stock market goes up. And they have since November 9, with the S&P 500 up nearly 11% after the election and before President Donald Trump’s administration had a chance to implement any of its pro-business plans.
But the speed of the most recent rally — which brought the Dow Jones Industrial Average above the 21,000 mark — made US stocks even more overvalued by most measures, and has some strategists eager for a pullback.
“Some kind of consolidation or pullback would be perfectly normal, and honestly, probably the best thing if you’re bullish,” Ryan Detrick, senior market strategist at LPL Financial told Business Insider. “You don’t want to see a blow-off top to 22,000 or 23,000 in a short timeframe,” he said, referring to the Dow.
The Dow’s move from 20,000 to 21,000 in 24 days matched the fastest thousand-point move recorded in May 1999. In February, the index recorded 12 straight days of closing at all-time highs, one day short of the longest streak.
“Don’t think that investors don’t want a pullback,” said Quincy Krosby, market strategist at Prudential Financial. “They want to burn off some of that froth, that enthusiasm, and they want valuations in stock prices to pull back in,” she told Business Insider.
Eight years and counting
Old age does not kill bull markets. But amid the second-oldest one in history, and with some measures of valuation and investor sentiment at levels last seen at previous market tops, the parallels to past bubbles are being drawn.
Professor Jean-Paul Rodrigue of Hofstra University is the creator of this illustration of stages of a bubble. We asked him where things sit now.
“I have given up a long time ago trying to make any precise assessment about market bubbles, particularly their blow-off, since a lack of rationality is more the norm than the exception these days,” Rodrigue said.
Based on the stages he outlined though, the market is likely somewhere between “enthusiasm” and “delusion,” before the top, he said. It’s just impossible to know how long it will take to peak.
Many stock market strategists, though, say it’s too soon to talk of a bubble because they see the economy underpinning much of the gains.
“We don’t think it’s delusion,” LPL’s Detrick said. “The economy is potentially backing some of this.”
That doesn’t mean a sudden drop of, say, as much as 10%, won’t be unnerving, he said.
“I’m going to guess that a lot of fear will come in a hurry because we’ve been so spoiled by all the moves” higher, Detrick said.
The Trump administration — which is promising tax reform, deregulation and heavy spending to boost the economy — has taken credit for the rally, and described it as a scorecard for the White House. And it could also be the trigger for its next leg lower.
“If there’s any deviation that looks as if he’s being forced to abandon tax reform, perhaps from his own party — those who are saying how will they pay for it — this market is going to have to recalibrate,” Prudential’s Krosby said.
‘Fear is your friend’
Based on the market’s history of eventually recouping its losses, a smart move in such moments has been to look for opportunities to buy.
“Widespread fear is your friend as an investor, because it serves up bargain purchases,” said Warren Buffett, Berkshire Hathaway’s chairman, in his most recent letter to shareholders.
Buyers taking advantage of the dip would be a sign that the pullback is not a longer-term decline, Krosby said.
The other would be if US economic growth holds up.
“I have a very hard time imagining that this bull market is about over right now,” said Randy Frederick, vice president of trading and derivatives at the Schwab Center for Financial Research. “If you look across the board at the economic data, there’s almost nothing in the economic realm that’s not at least moderately positive.”