Would a 5% – 10% Correction Really Be So Terrible?

As trading action has slowed down thus far in August, I took some time yesterday afternoon to reflect back on the year to date price action in US stocks.  The nothing short of pristine upside price action has led to both a sense of complacency on the part of the bulls and fear that even the slightest dip of 1% or 2% in the broader indices immediately leads to some sort of broader melt-down.  It’s a strange dichotomy of feelings on the part of the bulls, but the latter of which likely will be the reason why markets will continue to climb over coming years.  At the same time, its difficult to blame the bulls for feeling this way, after all the lost decade of stock prices still is a fresh memory.

The question I am pondering at this juncture is one of timing, for timing is everything.  While as a trader I can be quick and opportunistic to get in and out of the market, having a game plan on the medium-term trend of the markets never-the-less is of great importance.

So, for a little context let’s look at the sectors of the S&P 500, specifically the consumer discretionary group.  The S&P 500 is up roughly 155% from the 2009 lows, which logically means that out of the ten sectors, some must be up more and some less than the index.  Out of the ten sectors only the financials, materials, energy and utility sectors still remain below their 2007 highs, although they too are meaningfully higher since 2009.

The financials are up  roughly 240% since 2009, the transports over 200% and the consumer discretionary sector as measured by the SPDR Consumer Discretionary ETF (XLY) is higher by 280%.  The below multi-year chart of the XLY shows this well.  Note how it has eclipsed its 2007 highs long ago.

XLY weekly multi year

What I am concerned about over the medium-term of two to three months is the steepness of the slope on the long-term chart above.  On the chart below note the constantly increasing slope of the rally off the 2009 lows, which has recently moved the sector out of the up-sloping wedge in which it has been trading in for so long.  The trend is your friend until it ends, as the saying goes.

The question is, is it really so difficult to imagine a 10% correction in something that is up 280% in a little over four years?  I would argue it isn’t, especially as we slowly head toward a seasonally more volatile period in September/October.

xly multi-year wedge




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