As clients know, we always advise calm and patience when the market hits a particularly rough downdraft. This time is no different. We have several observations to share:

The quick and sharp pullback in stocks was triggered by last Friday’s weaker than expected monthly employment report. The number of jobs created fell well short of expectations and the recent monthly reports. The unemployment rate moved up to 4.3%, an acceleration of the slight upward trend so far this year. This news came while investor attention had shifted toward a slowdown in the economy after several companies noted weak consumer spending with their most recent quarterly reports. Sentiment had already shifted bearishly for the high-flying technology stocks driven by AI after recent earnings reports and guidance comments fell short of expectations. Against this background, the market has enjoyed an unusually long period of low volatility amid steady and significant gains. Based on market history, a correction was overdue.

Exacerbating the downward move, particularly in Monday’s trading was the historic 12% decline in the Japan’s main stock index. Japan faces uncertainty due to a weak yen and the Bank of Japan’s strategy to tighten monetary policy to defend the currency. Large institutional stock traders had been borrowing money in yen at minimal interest rates and using the funds to buy stocks outside the country, including in the US. As Japan rates rise, this trade needs to be reversed, leading to the heavy selling worldwide. This type of trading has little to do with the long-term economic fundamentals that Northlake clients should care about. Beyond this “carry” trade, there are other automated trades that can increase downward volatility including same day expiration options, algorithmic trades, and systemic strategies. These trades can be triggered by real economic data and developments, but they have little do with long-term fundamentals. Furthermore, these trading strategies accelerate the trend in place, leading to much bigger moves, especially to the downside. When Northlake’s sees this type of action, we discount the importance and focus on whether long-term investing fundamentals have undergone significant change. So far, we think they have not.

Northlake mentioned the possibility of a correction in our midyear letter, with a focus on the historically weak August and September calendar. We also noted modest recent weakening in economic data and the Federal Reserve’s acknowledgement that it was time to balance its mandate to support the economy and fight inflation.

While we see slower economic growth ahead, we do not anticipate a severe recession. Growth could shift down to barely positive or negative, but a sharper decline should be avoided as the Fed lowers interest rates beginning in September. We had thought the Fed would wait until December but understand a September cut is now likely due to market instability and weaker economic data than we had expected. The economic outlook remains positive. Inflation is down, interest rates are coming down, and most importantly, employment remains healthy, with the recent weakness just moving toward normal levels of unemployment.

Moderately slower economic growth and lower interest rates is still a good environment for corporate earnings growth and stocks. Most larger corporations have strong balance sheets that provide defense should a recession develop.

Finally, market history strongly shows that selling into sharp, fast downturns is a mistake. An article in Monday morning’s Wall Street Journal had some interesting data and comments highlighted below.

Noting that the VIX, the most popular measure of volatility had spiked from below 20 to over 50, the WSJ also found that “87% of the time, investors who bought the S&P 500 on days when the VIX closed above 30 made money one year later.” The WSJ also found that selling after large single day declines “is a bad strategy.” This is consistent with the many times we posted Ned Davis Research analysis on how markets bounce back from crisis events.

We believe client accounts are positioned to withstand bearish periods for the stock market. First, bearish periods tend to last weeks or months, while client time horizons are measured in years. If you don’t need all your money soon then there is time for the market to bottom and regain ground. Second, Northlake invests almost exclusively in high quality, financially strong companies that can withstand recessions and come out the other side growing and thriving. Northlake also invests heavily in widely diversified index funds that are dominated by an even broader array of strong companies.

The mental pain in downturns is difficult. Our experience in the market back to 1982 has taught us that it’s never as bad (or good) as current sentiment. The US stock market and economy have always bounced back in fairly short timeframes. Even if the current correction gets deeper, we do not think it will be different this time.