A Map Would Be Helpful - Part 2

By Charles Webb

For those who have been paying attention to the stock market the last few weeks, there’s little doubt that it’s been a little nerve racking.  Our clients will have or soon get our latest market commentary in their quarterly reports (see previous post).   In that commentary, we’ve addressed some of the reasons that we feel the market has sold off this month.  However, since then, we’ve seen even more volatility and a further selloff in the global stock market.  We wanted to send out this brief note to address the last few days’ activity.

As of this writing, stocks have had more days of triple digit declines, including an intraday move of -350 points on the Dow Industrial Average.  This has essentially put all the indices in negative territory year-to-date.  While the international concerns mentioned in our commentary are still the primary drivers, other news seems to have amplified this negative sentiment, the Ebola scare being the primary headline. 

Experience tells us that this piling on effect is fairly common.  When stocks top out, such as what we saw this summer, investors get nervous and begin looking for reasons to sell.  Initially, you’ll see the various parts of the market diverge from each other as investors naturally pull away from the more richly valued sectors.  We saw this trading pattern in September as the small and midcap sectors underperformed large caps. 

News concerning fundamental factors such as GDP and earnings drive most of this initial selling, but from there things tend to get irrational.  Once again, the Ebola news would fall into this category.  This is what you’d call “headline risk”.  There’s no reasonable explanation at this point to link stock market performance to something like a few people in the U.S. contracting a virus.  What it does, though, is create a catalyst for those looking for a reason to sell.  The trading jargon for this is “capitulation” and the financial news loves to report on it.

Whenever stocks reach historic highs, it’s necessary to have a periodic retreat to consolidate those gains.  Investors are never comfortable when things go straight up.  They always expect there to be a selloff.  Once that occurs, the feeling is that it’s now behind us and it’s safe to get back in.  You’ll hear a lot of talk of “10% corrections” and technical terms such as “200 day moving averages” being thrown around.  This is all just an effort to figure out when the sellers are done.

We never felt that 2014 was going to be a particularly good year, but we do believe it will finish positive for the year.  The good news is that bonds continue to rally.  For those who like to frequently look at their account balances, that will help.