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What Causes a Market to Rebound?

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RANDY FREDERICK: Equity markets are starting to recover from their first 10% correction in over two years, and it does look like the worst is probably behind us now. Jeff Kleintop joins me for the February 15th Schwab Market Snapshot to give us his thoughts of what caused it and what might have caused it to bounce back.

So, Jeff, it seems like last week’s decline is more likely to fall into the category of a market correction, which is a pullback between 10 and 20%, rather than a full-blown bear market, which is a decline of more than 20%. Now, bear markets have a tendency to happen during times of economic recession, and the market oftentimes doesn’t recover until the economy starts to get better. But what could cause the market to bounce back when there’s a correction?

JEFF KLEINTOP: Well, Randy, that’s a matter of great debate. Unfortunately, there aren’t simple rules to follow every time. It isn’t as easy as some articles or maybe financial programs make it seem, and it’s better, often, for long-term investors to let the correction run its course than to try and call the bottom. But that said, I think there are some misconceptions about what ends a stock market correction. First, the size of it. Often, people say, "Well, we need to get a 10% pullback." But the truth is corrections vary a lot in their depth and duration, offering investors little signal as to when they’ve actually run their course.

A second is that people believe the Fed will step in, that the Fed has some kind of level they won’t let the stock market get below before they take some kind of action. And that may make some sense when the pullback is related to economic weakness, but … and warranting some maybe … some more monetary stimulus from the Fed, but that’s not the environment we’re in now. Late in the economic cycle, what we’re worried about is overheating the economy than one that’s slowing down, so that one doesn’t really apply.

Three is valuations. Now, there are some that say that the stocks just need to get back to fair value, whatever that subjective fair value is. But the truth is stock corrections, pullbacks, have stopped at many different levels of the price-to-earnings ratio. There’s no one consistent level at which you can say, "Oh, that’s it; that’s the floor." So it varies quite a bit, as well, there.

And then, four, on technicals and moving averages. And, Randy, I’m interested in your thoughts on this. There’s some logic in believing markets just need to get back to their trend after overshooting.

RANDY: Well, as you know, Jeff, I’m one of those traders who believes that fundamentals and technicals both matter, and if you draw a trend line from when the last correction ended, which was February 2016, it does look like this correction brought the S&P 500 just about back to its long-term uptrend. If you overlay a 100-day and a 200-day moving average, it’s pretty interesting. I just think it’s important that we recognize that sometimes technicals matter because there are participants out there who trade on them. But at the same time, we also know that technicals are never an exact science, so what else might have caused this rebound to happen?

JEFF: Yeah, no magic number, right? Well, finally, maybe a change in the data, itself. This is a misconception, as well. Look, when the markets are responding to a weakening economy, as you talked about with a bear market in a recession, they’re just looking for a turnaround in that economic data. That’s not where we’re at now. At this point in the cycle, we’re not … we don’t want the data to roll over and get weaker. It’s strong right now. We’re more concerned about the degree of growth than the direction of growth. And because of the volatility of economic data, it can take some time for the trend to emerge for us to really get a sense of, you know, how strong is too strong when it comes to growth. So discerning that kind of subtle change in the degree of growth can take some time and be relatively challenging. So history shows us that corrections are common in bull markets and simply have to run their course, and we probably haven’t seen the last one this year, and so we’ll probably see more of these. But, unfortunately, there just aren’t simple rules to follow that work every time, and, again, it’s probably better for long-term investors to let them run their course, rather than try and call the bottom.

RANDY: All excellent points, Jeff, thank you. Listen, if you want to read more from Jeff you can do that in the Insights & Ideas section on Schwab.com. You can follow Jeff on Twitter @JeffreyKleintop. And, of course, you can always follow me on Twitter @RandyAFrederick. We’ll be back again. Until next time, invest wisely. Own your tomorrow.

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Definitions

S&P 500: a market-capitalization-weighted index of 500 of the most widely held U.S. companies in the industrial, transportation, utility, and financial sectors.

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