After a couple smooth years in the market, volatility has returned. The one question on everyone’s mind really doesn’t have a clear answer; why? Why did the market decide to plunge from it’s highs?
Jason Zweig writes:
Market commentators are already arguing that stocks were bound to fall because interest rates are rising and inflation is sure to jump as the economy heats up. But a week or two ago, before stocks stumbled, analysts were saying just as glibly that moderate increases in interest rates and inflation were good for stocks.
That’s what markets are like. Tens of millions of people don’t always act rationally in response to new information; often, they react to nothing but how they think other people are acting or will act. Logic can melt into emotion in the blink of an eye. – Jason Zweig
Clearly the better than expected jobs report and, more importantly, the higher than expected increase in wages, shuffled expectations about inflation, interest rates, and future action by the Fed.
Markets have progressed so smoothly over the past couple of years it seemed as if everyone had the same expectations and agreed on the path forward. The surprising labor reports seem to have spun everyone in different directions as they work to establish new expectations about the path forward.
It is interesting to note, the news that started the selling was good economic news. It’s a case of good news is bad news.
A look into the numbers…
The Wall Street Journal posted a list of data points about the market declines. Here are some of the bullet points along with some perspective.
Remember, our commentary is to provide a balanced perspective of market events. When investors are overly optimistic, we feel it’s important to call attention to risks. When investors are overly fearful, we feel it’s appropriate to call attention to opportunity in the market. All investing entails the potential loss of principle.
On with the list:
Get used to large numbers…
- The Dow ended the day 1,175.21 points lower at 24345.75, the largest one-day point decline on record. That marked a drop of 4.6%, the largest such move since August of 2011.
True, 1,175.21 is the largest point decline, but notice, we experienced a similar percentage drop as recently as August 2011. Yes, that was a while back, but the drop wasn’t historically unprecedented as some headlines would lead you to believe.
However, the large movement in DOW points should bring to our attention the fact that we must get used to dealing with larger numbers. Not typically this large, but with the DOW recently hitting it’s all time high above 26,000, percentage moves cover a larger number of points.
For example, in the 80’s it took a 100% up movement to grow the DOW from 1,000 to 2,000. Recently it only took 4% to grow the DOW from 25,000 to 26,000. The media loves to broadcast whenever the market crosses one of these round-number milestones, but the announcements grow less meaningful as they represent smaller percentage gains.
The steep ascension…
- Still, given how much the market has risen in recent months, the Dow and S&P are only at their lowest levels since Dec. 8 and Dec. 7, respectively.
Markets have fallen rapidly the last couple of days, but it important to keep in mind how rapidly they have risen. The DOW was up nearly 6% in January alone, a historic rise. So it’s not unheard of to have a steep reversal once new information changes expectations. As stated in the bullet point above, even with the steep declines of the past couple of days, the DOW and the S&P are only at their lowest levels since Dec. 8 and Dec 9, respectively.
Speaking of steep climbs, the market has climbed roughly 36% in less than 18 months (see chart below). It isn’t unreasonable that a correction occur to re-establish expectations about the future given we’re in the middle of Q4 earnings season. Note, we haven’t reached correction territory yet (as of 2/6/18), as defined by a retreat of more than 10%, but it seems likely we will.
Pullbacks have been and always will be part of the investment process
Three points and a chart about market corrections…
1. Stock market corrections happen often. The U.S. economy naturally peaks and troughs over time, and in response the stock market will also have its peaks and troughs. According to investment firm Deutsche Bank, the stock market, on average, has a correction every 357 days, or about once a year. Our last correction was nearly 1,000 days ago, the third-longest streak on record.
2. Stock market corrections rarely last long. Not counting our most-recent dip in the Dow, corrections in this century have averaged 87.8 trading days, or about 17 calendar weeks. In other words, stock market corrections often tend to be on the order of a few weeks to two quarters in length.
4. Stock market corrections only matter if you’re a short-term trader. Stock market corrections really aren’t an issue if you remain focused on the long-term with retirement as your goal. Maintaining a long-term view has been the smartest way to invest in stocks throughout history – and it also happens to be a recipe for a good night’s sleep.
Below is a chart which puts the effects of Bull and Bear markets into perspective. No, we aren’t in bear market territory, we haven’t even crossed into correction territory, but even with more severe down markets, it pays to be a disciplined investor. Further, the blue parts of the graph (the good times) contain several pull backs and corrections within them, further illustrating the senselessness of focusing on short term volatility.
Simple rules for the chart below:
- Blue is an image of bull market lengths and height of returns.
- Orange is for bear market lengths and depths of losses.
- Stare at how much blue there has been since 1926
- Stare at how much orange there has been since 1926
- Ask this question: “Why in the he$$ am I always worrying about the orange?”
…end of lesson.
A couple other points on the Wall Street Journal’s list are worth mentioning since they’re the types of negative data used to heighten investor fear and anxiety. I think the WSJ is better than most, but others with similar data are less benevolent.
- All 30 components of the Dow were down Monday. That is the second day in a row that all components were down. The last time that happened was August 24, 2015.
- The S&P 500 is currently down more than 2% for the second consecutive day, the last time it closed with back-to-back 2% declines was August 2015.
Both the above data points are of course true, but again, not historically unprecedented. They are also irrelevant and useless to investor decision making. But they do stoke emotion, which is enough to make for a headline.
The media knows we, as human beings, are addicted to fear. We stay tuned and consume as much data as possible when we are fearful, uncertain, and/or anxious. In fact, after Friday’s market decline of 665.75, many in the media debated the ethics of rounding up to 666 just to invoke images of the devil.
Cue all the headlines and splashy photos with devil references by market watchers who rounded the closing figure up to 666. Even CNBC went with the 666 figure after some internal debate. As CNBC markets writer Fred Imbert will tell you as he’s trying not to blink while watching the Dow when it’s up 99.9 points, he can’t change his markets headline to reference 100 points until it’s official — no rounding allowed. This time, though, the temptation of headlining a market gutting of — nearly — 666 points was too much to resist.
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