The Great Correction Of 2014? Don't Drink The Kool-Aid

| About: SPDR S&P (SPY)


There has been vast speculation by many that the day of reckoning for the rally in the S&P 500 is upon us.

I beg to differ my friends. Although a day of reckoning is inevitable, we are nowhere near that point.

In the following article I will explain why the markets remain fairly valued even though they are up significantly from the 2009 low.


The S&P 500 (NYSEARCA:SPY) is at all-time highs, there is no disputing this fact. Yet, this has been one of the most unloved rallies in the history of the stock market. Many are suggesting the day of reckoning has arrived and it is time to run for cover. In the following piece I will do my best to deconstruct the current state of affairs in the market. Further, I will attempt to differentiate what is real from repartee and come to a conclusion about what lies ahead for the S&P 500.

Historical Perspective

I think some of the thinking regarding where the market currently sits is somewhat flawed. Many cite the incredible run from the 2009 trough to the current 2014 all-time high of over 180% as a sign it's time to get out or buy protection. And they may be correct. I am not saying I know what will happen in the future. If anyone tells you they do, run for the door immediately. What I am saying is their thinking may be flawed and based on the wrong metrics. Let me elaborate.

The wrong take on the bull run

Many pundits out there point to the fact we are up over 180% from 2009 in the S&P 500. Further, it has been widely noted that in the last decade investors have had to endure two major bear market corrections. See chart below.


The problem with this analysis is the focus on the incorrect metric in my view. The prognosticators of doom are looking at price rather than value. And, as anyone worth their salt knows, it is not about price, it's about value. This is the crux of my argument. When I look at the same chart from a value perspective I come to an entirely different conclusion. See chart below.


In actuality we have only gained 30% over the past 14 years. This is the statistic you need to focus on I surmise. Remember the statement:

"Price is what you pay, value is what you get."

Looking back on the past two peaks and troughs, it's easy to get scared - we have overshot to the upside. Yet, if you look at the underlying fundamentals of the market, we are actually nowhere near those nosebleed levels. The current P/E ratio of the S&P 500 now sits at approximately 17. At the peak of the 2000 dot com bubble it was 32. That's about twice as high as today. In order for us to match that level in today's market, we would be looking at an S&P price level of nearly 4000, not 2000 as it stands today. So we are not even close from that perspective.

Second, regarding the 2008 peak of the housing bubble, the S&P 500 P/E ratio was approximately 22. That's about 25% higher than it is today. So we would have to reach 2500 in the S&P prior to matching the 2008 level.

The fact of the matter is the S&P 500 is actually fairly valued at this time. The index is trading on par with its historical post war level of 16. This is reality folks. Now, I'm not saying a correction could not happen. Let's discuss this further.

A day of reckoning is inevitable, but nothing to fear

A day of reckoning is always on the horizon. I just don't think it's coming anytime soon. When I say "day of reckoning," I'm talking about a bear market correction the likes of the past two big ones of over 20% in the last decade. There will always be pullbacks, which are 5% or less, and corrections, which are approximately 10%. But these are actually healthy for the market. See chart below.


As you can see by the chart, we have had several pause and refresh cycles on the way up. Furthermore, the trajectory of the ascent in the S&P 500 is nowhere near parabolic. A parabolic move is the telltale sign that the end is near. I have yet to see this materialize. Let's move on and take a look at what happened after one of the greatest crashes in stock market history, 1987's Black Monday, to gain even more perspective.

1987 Black Monday Crash

First, riddle me this, how many times has the stock market roared back after a correction? The answer is every time. Those are pretty good odds, wouldn't you say? If you told someone in 1987 on Black Monday that the Dow would be almost 10-fold higher within 20 years' time, what do you think they would have said to you? I can tell you right now for a fact that person would have called you crazy. Nonetheless, you would have been correct. For me, that day was the genesis of my contrarian roots. So even if there is a correction of 10%, it is nothing to fear essentially. If you don't buy on margin and have a long-term outlook, you will be fine. Here is more proof as to why.

Who is to say how high the market can climb?

Maybe Bespoke Investment Group can shed some light on the subject. Bespoke Investment Group is always digging up interesting statistics. Here is one I feel pertains to the current environment. Bespoke Investment Group, the all-time king of market statistics, states:

"Since 1928, S&P averaged gain of 5.55% in quarter after a 10%+ down quarter."

This indicates that over the long haul you will win out if you stay the course and hold for the long term. Now, let's dig into what's going on right now in the markets and economy. These factors may determine what happens next. I will break the factors out into positives and negatives.

The Negatives

  • Fear of a correction is rising as stocks continue to hover at precariously all-time highs.
  • A day of reckoning is inevitable due to the fact much upside has been pulled forward by the Fed's QE program.
  • Nothing good lasts forever.
  • The global growth outlook is somewhat flat currently.
  • Anything can happen regarding geopolitical events in the Middle East and Eastern Europe that could tip the apple cart in an instant.

The Positives

  • A ton of money remains on the side lines due to the ever present doom and gloomers who have been predicting a correction for the past year.
  • The S&P appears to be fairly valued and is trading on par with its historical post war P/E level of 16.
  • Expectations are set extremely low at this point. Any uptick in the growth outlook and we could be off to the races.
  • Multiple expansion could occur based on an increase in earnings.
  • The US Economy and stock market remains the cleanest shirt in the hamper which should continue to draw in foreign dollars.
  • The North American shale oil boom has turned the world on its head in regards to the oil and gas markets. This bodes well for the US economy as energy prices may drop while a significant amount of wealth is being created.
  • The resurgence in the housing market has put homeowners at ease. Prices have increased substantially across the board and pulled many homeowners' heads above water.
  • The wealth effect created by the rise in stocks may spur further growth.
  • Baby boomers on the hunt for yield are buying up high dividend low beta stocks providing them with the opportunity for capital gains and income production.

I say the risk/reward equation still favors staying long at this point. The positives vastly outweigh the negatives in my book. I would appreciate anyone who wishes to add to either list to please post them in the comments section. Thank you.


It is hard to think beyond the current state of affairs when negative preoccupations about the market being at all-times highs are repeated incessantly. The problem is that when you do finally decide to jump in, it's already too late due to the fact savvy investors bought in earlier and ran up the prices while you were hiding in your storm cellar waiting for the sky to fall. Fortune favors the bold my friends. Take it slow and layer into a position over time is the way to go about it in times such as these.

Final Thought

There may be more volatility in front of us, even more than a 10% drop in the market may occur in the near-term. Nevertheless, history has proven these types of occurrences are transitory in nature. The market inevitably digs itself out of the hole and trudges its way higher every time. History is on my side.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.