Learning from Past Market Correction Modes

Last month, I discussed how there are many similarities to 2007, with volatility and bond prices moving together. Couple some economic data like housing permit growth, PE for stocks, a rally in gold, and household debt all looking like 2007 numbers with volatility and bonds looking like investors are getting ready to head for the hills in the stock market, and the backdrop looks like a recession was imminent.

Since then, the market has turned into correction mode and has really started to pick up steam to the downside. Especially at the start of last week when the market cratered down 7.8%. It brought back feelings of a 1987 Black Monday.

In both 2008 and 1987, a contagion effect occurred in the form of a credit crisis whereas the domino contagion effect happens to be a disease grinding the economy to a halt now. The key word here is “halt.” Halting of money supply movement throughout the world disrupts the current pie system. And, it is no so much that the pie or money supply has shrunk, but it is the fact that certain pieces of the pie need money supply to not disrupt the credit system.

What we haven’t seen is the reduction in economic activity yet, but I do believe the transfer of type of activities is occuring. Instead of going out to eat people are stocking up at items bought at the grocery. People are also working from home. If the corona virus scare can be dealt with within the next few months, the damage may be minimal. However, if the damage to the tourism/travel/hotel industries is as bad as some fear, there could be a major distribution which could cause a recession. And if it continues, then I fear bankruptcies looming, causing major losses to banks, and then unemployment rising, and then slower economic output.

If you compare 2020 to the 1987 crash time period, then the market might be in early stages of a selloff since 1987 gave back all of its move that would correlate with the previous time frame from 12/24/2018 to the 2020 highs. The reason for comparing ’86-’87 to ’19-’20 is because both market time periods were highly correlated in the previous five years and both time periods saw tremendous run ups off a significant sell off event like was seen in December 2018. In 1987, the crash went all the way down to a blip low seen in 1986 similar to the blip sell off of December 2018. Thus, if the current market continues its correlation then returning to the December 2018 lows might occur, down still over 10% from current levels. If however, the added blow off top in July of 1987 exacerbated the down move in October, then maybe the current market holds the lows of today.

But that’s just history, this market is completely different. Prediction is very difficult, especially if it’s about the future, and those who know the future, do not predict it. But here is a prediction I don’t mind sharing: over 120 years of public markets in America, given a long enough time horizon, the market went higher, and given a long enough time horizon the market has significant corrections.