“Be fearful when others are greedy. Be greedy when others are fearful.” – Warren Buffett
In the last six trading days, the Dow has plummeted more than 2,100 points, or 8% giving up year-to-date returns. The recent losses have put just a dent in the overall gains since stocks took off the beginning of November 2016. The Dow and Nasdaq remain up nearly 40% over the last 15 months. Even with the big drops on Friday and Monday, equities are still not far from all-time highs. When the public is used to seeing stock prices rise daily, a significant loss will create headlines.
Why is the Market Dropping?
Experts are divided on why the markets have dropped over the last week with no clear answer. One theory is the markets are testing new Fed chair Jerome Powell. Coincidental or not, in the first months of tenure for new Fed chairs there has been a fairly significant stock market selloff, the most famous of which was the 1987 Black Friday market crash shortly after Alan Greenspan became Fed chair.
Other experts point to rising interest rates as the reason for the market selloff. Rising interest rates can impact multiple facets of a corporation’s profits. Rising interest rates can increase the cost of borrowing for corporations, increase inflation which increases labor costs, and increased interest rates can make lower risk bonds a more attractive investment than stocks. All of these things are happening or on the horizon.
Finally, I believe stocks have risen too far, too fast. They have risen in a straight line since November of 2016 which is not exactly healthy. The markets are overdue for a 5% pull back or even a 10% correction (which we now have achieved). A cooling-off period is a good thing bringing balance to the markets. It will make stocks cheaper and more attractive to investors, especially if the underlying companies are healthy, producing strong sales and profits.
Recent Historical Perspective
The stock market is amazingly resilient. In the current bull market, which started in 2009, it is easy to forget we have seen multiple negative market events.
A stock market correction is normal. In fact, corrections are a natural and healthy part of the economic business cycle and the market cycle. Since World War II, the markets have had 76 pullbacks of 5 to 10 percent, 26 corrections of 10 to 20 percent, eight bear markets of 20 to 40 percent and three severe drops greater than 40 percent, according to Ned Davis Research. Over the long term, this averages out to about one pull-back every year. What this tells us is last year’s stock market was not normal and we are due for a correction or a “reset”.
2016 began with the worst start to begin a year in the history of the stock market. This was followed by a huge drop in stocks in the middle of the year due to Brexit only to end with the markets up double digits by the end of the year. There have been multiple significant pullbacks in the markets since our bull market started in 2009.
A Look Forward
With 17-year low unemployment, high consumer confidence, rising wages, growing international economies, and huge corporate tax cuts, there is no sign of a recession on the horizon. What we are looking at is a healthy reset of the stock market. With possible uncertainty in Washington this week, the markets may continue to remain volatile until a government shutdown spectacle ends. With a strong economy, the rest of 2018 looks promising for stocks. Over the next week, take a deep breath, understand that you are diversified according to your goals, and try not to watch cable news.