An old saying on Wall Street is that stocks take the stairs up and the elevator down. As I write this, after the close on Monday, February 5, it is clear that the elevator is packed. The Dow Jones Industrial Average is down 1,800 points over the past 2 days. Today’s 1,175 point drop was the biggest point drop ever. While the sizes of these point drops are high, percentage-wise, they are reasonable: The Dow is down about 7% from its all-time high, which we hit a little over a week ago.
Why?
There are a lot of reasons being given by the financial media as well as market analysts as to why we are seeing this sell-off. My take regarding these reasons is that they are valid but that they should not result in panic selling:
- Friday’s Jobs Report was too strong: The US economy added 200,000 jobs instead of the expected 160,000. In the convoluted reasoning of Wall Street, this is bad news because it means the economy is growing stronger than expected. Don’t surprise Wall Street analysts, or it will come back to bite you.
- Interest Rates are Rising: Yes they are, but the rise seems to be in line with expectations, and it is probably a healthy thing. The Fed has said they intend to raise short-term rates by 75 basis points this year. The speculation now is that the Fed will raise more than that. The market can handle 100 basis points. The 10 Year Treasury Bond yield has now risen to 2.88%, from the 2.4%-range as of 1/1/18. However, at 1/1/18, the yield curve was too flat, meaning the difference between short-term and long-term rates was too small. The yield curve is now steepening, which is a sign that investors see the future as good. There was no good reason why the yield curve was flattening. A flattening or an inverted yield curve portends a recession, and there are no signs of recession looming out there.
- Technical Indicator Busted: The major averages today traded below the 50-day moving average, which is a technical indicator. Some algorithms are programmed to sell when a security breaches the 50-day moving average. A breach of a technical indicator is not a sign that there is something fundamentally wrong with the economy, although it is not without meaning.
- Program Trading: At one point, late during today’s trading session, the DJIA dropped about 1,000 points over the course of about 30 minutes. That is almost always indicative of a large institutional trader trying to exit a large position at market. Again, this does not mean there is something wrong with the economy, just that there was a big seller for whatever reason.
- The VIX: The VIX Index moved up 115% today alone. Because the VIX Index is made up of Put options, Put options being options to sell at a given price, the explosion in the VIX today is almost certainly because of large institutional investors piling into Puts.
Not a Reason Given
What is not given as a reason for this market sell-off is anything major that was unexpected or anything deeply fundamentally wrong with the economy. For instance, the 2007-2008 sell-off was due to the revelation that there was insufficient or even fraudulent collateral behind the mortgage-backed securities market. The sell-off in August 2015 was due to an unexpected devaluation of the Chinese currency. Likewise, the correction in January-February 2016 was caused by China issues. Other sell-offs were triggered by information that the economic or financial world was about to upend. There is nothing out there to indicate we are about to go into a recession, either here in the US or in most other major economies. China is not changing course right now.
IMO
Since I don’t see anything that is fundamentally changing with the economy, and while there are always geopolitical issues looming out there, there is nothing imminent. The Market has traded steadily upward, taking the steps, especially since President Trump’s election in November 2016, without ever having had a correction. Markets never go straight up forever. There is always digestion required. What we have seen in the last few days is the return of the volatility that we haven’t seen for many months, but that is historically normal. The elevator down was empty, and a lot of people piled in. I am not saying this is a dip to buy, but I do believe this sell-off is not indicative of a major change for the worse in the economy. Remain calm. At least for now.