Stock Market Declines over 2% on Friday

February 03, 2018

As you’ve likely heard on the news, the broad stock market indexes were down sharply yesterday.  The day started down and continued to decline with only a few times where it looked like buyers were coming in to offer support.  At the end of the day the Dow was down 2.54%, the Nasdaq down 1.96% and the S&P 500 was down 2.12%.

If you had been watching CNBC throughout the day like I did, you would have seen news anchors and guest speakers alike acting like this was another 2008 market crash.  There was all sort of speculation as to why the sellers were selling and the buyers weren’t buying, lending to this precipitous decline.

In politics, there was the much talked about release of the “Nunes memo”, and some said this was what initially scared traders:

Then in bond market news, there was a relatively large jump in interest rates with the 10-year treasury yield popping up to 2.85% after the January jobs report showing strong wage growth spooked investors that a pick-up in the inflation rate could finally be on its way.:  -and-

While the inflation story has more to do with it than the Nunes report, the market has been bracing for and getting ready for higher interest rates for quite some time.  I think the more likely cause for the decline is plain-old vanilla profit taking activity by professional traders and money managers.  There was no “flight to quality” activity going on, meaning traders were not selling stocks and buying US treasuries.  In fact, treasuries and high-quality corporates declined in price somewhat on the day due to the rise in yields.  If there had been a ton of money flying into US treasuries in a panicked manner, their prices would have risen on the day.  Furthermore, gold even declined, which usually goes up in stock market panicked sell-offs, as well as when inflation expectations are higher than normal.  (The GLD, an ETF that tracks the spot-price of gold, was down 1.31%).  Again, more likely due to the fact that the GLD had risen approximately 9.5% from trough mid-December to its peak just last week, and it was time for traders to take their profits.

Why this day felt so bad and out-of-the ordinary, is because market participants have gotten so used to stocks going straight up with little to no volatility, that compared to the way things have gone lately, it was anything but an ordinary day.  To say that investors have become complacent is an understatement.

The fact is that this has been the longest rally without a 3% correction in history - 453 days to be exact, going back to November 2016.  Furthermore, yesterday marked the largest daily decline in the S&P 500 since September 2016, and it has, so far, been 720 days without an official “market correction” of a 10%+ decline.

Market pundits have been calling for a market correction so often over the past year that their cries have fallen on deaf ears, much like the boy who cried wolf in Aesop’s Fable.  Well, it’s quite possible that we are at the beginning of a correction.  Historically, corrections take place over the course of weeks to months, so we may not know for sure until we look back on it.

I do not think this is the beginning to a larger, and more long-term, decline as defined by a “bear market” of a 20%+ decline.  By most measurements, the US (and global) economy is on a tear, and there’s little indication it will slow down anytime soon.  The Conference Board released their Leading Economic Index last week on January 25th and called for economic growth to continue through the first half of 2018.

Furthermore, some of the best analysts and investment banking firms in the world all say that a correction in equities would be a buying opportunity.

However, it is likely that we will see a return to a more “normal” market with a pick-up in volatility.  This is where having a well-diversified portfolio comes into play – especially for those that are retired or nearing retirement.  Having high-quality bonds in your portfolio, while not particularly sexy, does provide diversification and downside protection.  And, while rising interest rates are expected to put downward pressure on bond prices, their yields still provide income and total return to portfolios.  Furthermore, if there happens to be a large sell off in stocks and a flight to quality does occur, then those bonds will provide some off-setting gains.  This article from Ben Carlson he wrote for Bloomberg View in November of last year is a good read on this topic.

We will likely see more declines next week.  It will be interesting to see what happens on Monday.  The selling will likely continue, but to what degree is the question.  The best course of action is to simply not panic and feel like you need to sell everything in your portfolio.  We’ve been through this many times before, it’s just been a long time since we’ve been reminded that the market does actually go down sometimes!

Please contact me if I can be of help.