Has the Selloff Got You Sweating? Read This Before You Panic.

Posted by jbrumley on February 5, 2018 3:54 PM

It's a bit ironic, really, when you stop to think about it. Just a couple of weeks ago some pundits were calling more a market meltup, touting the number of weeks the S&P 500 had gone without a correction of 5% (or more), suggesting it would never happen again. As of Monday's drubbing, the S&P 500 has lost more than 5% of its recent peak price, and seems more than able to keep moving lower.

Maybe the weakness will last. Maybe it won't. There's no denying the sheer scope and speed of the selloff sets the stage for a potential dead-cat bounce, just as assuredly as there's no point in pretending this selloff wasn't due sooner or later. The big take-away for investors right now is, what do you do about it?

The answer is two-pronged.

  • First, take a deep breath and relax. This happens. It's not happened in a long while, but it happens. We'll get past this dip just like we got past all the others.
  • Second, don't forget that for all the volatility and terrifying headlines, Q4's earnings season has been going quite nicely.

If you're like a lot of traders, you may have forgotten we are indeed in the middle of earnings season. So far, so good. A little more than 77% of those companies topped estimates, and only 14% fell short; 9% of them met earning expectations. That's a bit better than average.

The really encouraging part of the story so far, however, is the bottom line result. With half the market reporting in, the S&P 500 is on pace to post earnings of $33.47 per share, up almost 20% on a year-over-year basis. [Click on the chart for the full-screen version; the pink arrow is Q4's result.]


That is less than the $34.10 per share analysts were collectively calling for just a couple of weeks ago, but that overshoot isn't anything new. We usually have to temper expectations mid-stream.

The energy sector is driving a huge chunk of that improvement by the way. Though it's still miles away from the chipping in about a tenth of the marketwide bottom line it used to chip in before the 2014/2015 meltdown, it's improving by leaps and bounds. Q4's earnings for the energy sector were up 946% year-over-year; just bear in mind that was a very low comparison basis. Also impressive was the 30% improvement in the technology sector's earnings, and the 49% increase in profits for the materials sector. Telecom profits fell 24% year-over-year, but they only make up a tiny portion of the S&P 500's bottom line. Each sector's year-over-year comparison is below.


Also note on the first chart, however, that the market's overall earnings have been and remain on an encouraging trajectory. The biggest pitfall was valuations, which have changed dramatically the past few days. The S&P 500 is now trading at a trailing P/E of 21.6, and a forward-looking P/E of 17.4. Both are above norms, though the latter is less so. The typical forward-looking P/E is around 16.0 -- sometimes less -- while the average trailing P/E is between 17.0 and 18.0.

As for what that means for stocks, yes, it leaves room for further downside, though hardly guarantees it. It's also worth knowing that while more downside may be in the cards, we won't necessarily have to see it unfurl right away. The bulls will likely push back soon. It remains to be seen if they'll be able to rekindle the longer-term rally or not. We're guessing not, though that likelihood brings us to a key point...

Don't confuse this weakness for the beginning of a bear market. And, certainly don't confuse this selling as the beginning of a recession. This selloff from the stocks is little more than a much-needed correction. Earnings are still on the rise, and strong economic growth is still providing a tailwind. This is a buy-on-the-dip situation, even if it's not a scenario where you want to try and catch a falling knife by making a purchase sooner than later.

That's not a perspective you'll get from (or even be able to glean from) today's headlines.

It's admittedly a tough thing to do.... keeping your cool when there's so much red from every corner of the market. That's precisely when and why you want to keep your cool though. Their panic will drive traders to make emotionally-driven mistakes that become opportunities for you, even though this is all likely to end up as little more than a garden variety correction.