These have been wild days for U.S. equity markets. Since Friday, the S&P 500 erased all its 2018 gains. Monday was the worst day for equities in more than six years. In two trading days, the S&P 500 lost 6.13%. Right after it opened on Tuesday, the New York Stock Exchange dipped into correction territory. Fortunately, it reversed course and quickly moved back up.
“Corrections” are defined as a 10% drop in markets to adjust for overvaluation. Markets can correct when investor optimism pushes prices too far ahead of underlying fundamentals, leading to profit taking. This can stoke broad panic selling that pushes prices even lower.
In review, cyclical sectors, such as information technology and financials, alongside energy, realized the steepest losses. Five stocks contributed roughly 20% of the S&P 500’s losses over Friday and Monday: Apple, Microsoft, Exxon, Berkshire Hathaway and Alphabet. Defensive sectors such as utilities and real estate drew down the least as investors sought refuge.
Still, the S&P 500 index remains at levels achieved on Dec. 8, 2017. The S&P 500 is trading at 22 times trailing earnings, near the highest since 2004, according to FactSet.
Our 2018 market outlook remains positive: We believe U.S. equities should deliver positive returns for the upcoming year. This should be driven by healthy U.S. and global economic growth; continuing U.S. earnings growth; and strong consumer spending, owing to low unemployment.
Investors should stay in U.S. equities but pursue a well-diversified strategic asset allocation that includes defensive equities to help smooth the ride. Defensive equities can help investors stave off market-timing decisions that are so detrimental to long-term returns. Over the last 35 years, the best predictors of defensive equity success are periods of low volatility (when they generated 4% outperformance) and strong economic growth (5% outperformance).
At the moment top sectors to invest in include industrials, utilities and consumer discretionary. Sectors to be careful of include technology, which has had a great run, so now may be a good time to rotate.