A stock market correction, technically speaking, occurs any time a major benchmark index loses at least 10% of its value. When an index suffers losses of 20% or more, it earns the right to be called a “bear market.” On average, stock market corrections occur every 1.5 years, while bear markets occur about every nine years.
As you may have noticed, the U.S. stock market has been humming along nicely for a few years now. In fact, if you include dividends, the S&P 500 hasn’t lost ground in a full calendar year since 2008, when the global financial crisis sent the benchmark index down 38%.
Today, we can hardly go a week or two without hitting fresh all-time highs.
Don’t get used to it.
The Markets Are Quiet … Too Quiet
The last stock market correction in the U.S. began in August 2011, when an inept U.S. Congress stalled on increasing the U.S. debt ceiling and quarreled incessantly over the federal budget, causing Standard & Poor’s to downgrade the sovereign debt of the United States. Eventually, stocks recovered, and on Oct. 3, 2011, they began a multiyear rally.
When markets close this Friday, April 17, Wall Street will reach an historic milestone: Barring a sudden, 10% drop in the stock market between now and then, the S&P will notch its second-longest period without a correction in the post-war era. The rally will have gone on uninterrupted for 1,292 days, or just more than 3.5 years.
That fact in and of itself isn’t enough to make a 10% stock market correction imminent in 2015. But that fact combined with frothy market valuations and worrisome economic indicators make a pullback far more likely than usual.
The S&P 500’s current price-to-earnings ratio sits at 20.5, more than 20% higher than its long-term average of 15.5. Valuations are at multiyear highs, and a number of high-profile stock market darlings enjoy downright criminal valuations:
- HomeAway, Inc. (NASDAQ:AWAY) stock trades at 230 times trailing earnings despite sharply decelerating revenue growth (and 40 times those sliding forward estimates) and an easy-to-enter industry.
- Tesla Motors Inc (NASDAQ:TSLA) stock commands a valuation of 52 times 2016 earnings.
- Twitter Inc (NYSE:TWTR) stock also gets the benefit of the doubt from Wall Street, which values shares at 64 times projected 2016 earnings.
- Amazon.com, Inc. (NASDAQ:AMZN) stock, no stranger to ludicrous valuations, trades at a staggering 168 times projected 2016 earnings.
The list could go on, but you get the point: this is the market of the growth investor.
But Economic Data Don’t Point to Huge Growth
The wildly bullish multiples we’re seeing in the stock market today might be somewhat defensible if there were good reason to believe huge growth opportunities were on the immediate horizon.
Alas, nothing implies we can expect these good tidings.
Consider the fact that consumer spending — which accounts for roughly 70% of gross domestic product — has basically been flat or falling for three consecutive months, despite the fact that the American consumer is saving gobs of cash on rock-bottom gas prices.
And with wage growth clocking in at a measly 1.8% in March — nearly 60% lower than the 50-year historical average rate of 4.3% — there’s no reason to expect any meaningful upticks in consumer spending anytime soon. Consider that Core CPI, a commonly used measure of inflation, was up 1.7% in February, and wages are essentially flat year-over-year.
So without the U.S. consumer to drive the American economy, what about Corporate America? Things surely look brighter there, yes?
No. No, they do not. It’s the beginning of earnings season on Wall Street, and for the first time in six years, analysts expect S&P 500 earnings to actually decline, to the tune of 2.9%.
With stocks priced to perfection, long overdue for a correction, and void of any clear bullish catalysts, keep close tabs on your portfolio.
That 10% decline could be lurking right around the corner.
As of this writing, John Divine did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @divinebizkid or email him at firstname.lastname@example.org.
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