Market Drop Was No Big Deal

The stock market has been setting records for years and it set another one last week. This time, though, the record wasn’t for the highest ever Dow Jones Industrial Average. It was for the largest point drop ever for the Dow, as we discussed yesterday.

To put this in perspective, consider that January’s stock market performance was the best in 31 years, finishing the month up more than 6%. That’s a pretty good return for a year, let alone a month.

And with the Dow over 26,000 when the drop began, a 1,175 point decrease represents a drop of about 4.5%, which means that the Dow was still up for the year after the decline.

Returns such as the market saw in January are unsustainable, of course. Markets moved too quickly and were over-bought short-term. Then the wage inflation number spooked investors, serving as a catalyst for the market correction. It was long overdue, as the market had gone 440 trading days without a 3% correction.

Investors also assumed that new Fed Chair Jerome Powell would raise rates more aggressively. That’s an odd assumption, given that he has consistently voted along with his predecessor and given, too, that it’s highly unlikely he wants to be responsible for bursting the market bubble. He is more likely, in fact, to talk down future interest rate hikes.

Still, we will be monitoring the Fed’s actions closely in the coming months. As MarketWatch observed, “Even though they told us, and most of us believe, that QE (quantitative easing) was responsible for the inflation of asset prices across the board, somehow quantitative tightening (QT) is not supposed to have the opposite effect.”

A potentially bigger concern will be the Fed’s unwinding of its $4.5 trillion bond portfolio. Adding even a portion of the portfolio back into the market could cause havoc. How much, we don’t know – the action is unprecedented.

A Technical Analysis

Putting aside jitters about wages increasing, the market also broke its 50-day moving average on Feb. 5 and machine trading, which is rule-based, perpetuated the downside trading after the technical break.

Overnight, a leveraged VIX (volatility index) product moved 80%, which further augmented market reaction. It will be important to watch and gauge whether we hold key levels in the market. The machine reaction began subsiding quickly, but the market has been volatile.

Fundamentals remain strong and, with economic strength building, it makes sense to remain invested in stocks, but to also keep a close watch on day to day events.

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