DJIA Down Big – Panic or Don’t Panic?
Okay, there are multiple issues that I just don’t like about this statement, yet news outlets are flashing this headline. I can already hear them tonight on the TV.
First, the Dow Jones Industrial Average (DJIA) is not the market. It’s an index of 30 stocks. Second, the primary reason the DJIA was down 1,597 points or 6.26% at one point today is thanks to program traders. How does that work? In short, once a price is hit on an index (or on other investment indicators) usually based on extreme movements, quantitative based trading programs automatically sell or buy. That happened at approximately 3:03 pm. Over the next 7 minutes the DJIA dropped over 860 points or 3.5%. That put the DJIA down nearly 6.3%. Good thing. The exaggerated selloff created a buying opportunity and the market recouped those 800 plus points before eventually closing the day down 4.6%. More importantly, the broader based S&P 500 (index of 500 companies) was down 4.1% for the day. The S&P 500 is now down approximately 0.92% for the year.
Reeding between the lines, let’s look at what is more important and really underlying all of this.
So, What Else is Going On?
In short, one of the reasons the markets sold off last week and again today is based on a quick year-to-date rise in interest rates. Ironically, a rise in interest rates is often a sign of a strengthening economy. Nonetheless, quick moves in rates can cause people to get nervous and fear that the economy is either growing too fast or that the Fed is choking off a sputtering recovery with higher interest rates. Aren’t these views contradictory? Yes. Welcome to the investment markets.
One way to check the health of the overall market is to see how the bond market held up on a day like today. On that front, it is a good sign that the 10-year Treasury responded favorably by increasing in price with its interest rate dropping from 2.84% to 2.71%.
As we also noted in our recent market commentary, rates tend to increase after tax cuts. Using 2003 as an example, we note that there was an increase in the 10-year Treasury rate from 3.1% to 4.6% with a corresponding equity sell-off of approximately 4.5% over six weeks. However, equities then climbed 15% higher over the next several months. While no periods are totally alike, this is good context for us today, particularly based on a strengthening economy and strengthening corporate earnings.
Economic Data Remains Favorable
Last week unemployment numbers beat expectations. The U.S. added 200,000 jobs and increased wages in the month of January. Unemployment remained at 4.1% as the U.S. continues to march towards “full employment.”
With approximately 50% of S&P 500 companies reporting earnings, 75% have beaten “earnings” expectations and 80% are beating “revenue” expectations. The latter is particularly important as earnings can be manipulated, less so for revenues. According to FactSet, if 80% is the final number for the quarter, it will mark the highest percentage since FactSet began tracking this metric in Q3 2008. And, according to Strategas Research Partners, which had a recent 78% reading, this is much higher than the average of 59% since 2002.
Panic or Don’t Panic?
Don’t panic. Markets can be irrational. Using this as a premise and the fact that markets generally sell off in advance of recessions or in response to unexpected exogenous events, we aren’t overly concerned with today’s sell off. We consider this a healthy breather for the markets, which also gives us more attractive valuation levels. While we continue to focus on fundamentals, we cannot predict when corrections start or end.
As per our recent market commentary, we did predict that we would see more volatility this year. We wouldn’t recommend changing any strategic allocations based on recent events. Naturally, we will continue to monitor the markets and ferret out any other underlying issues that may be at hand.
Please read our recent Winter Market Commentary for more context, view our 10 predictions for 2018 and overall portfolio implications.