Over the past few months, the stock market has been reaching record highs never seen before, setting milestones on what feels like a daily basis. The Dow Jones Industrial Average surpassed the monumental mark of 25,000 in early January, and the Nasdaq Composite topped off at an incredible 7,505 in January as well. The market has been exploding at a faster rate than we have seen in a long time, and business seems to be booming. However, all good things must come to an end, and that end may be closer than one might believe. Although the stock market had been constantly increasing since the 2016 election, the past week has brought a drop in stock prices. Last week, both the S&P 500 and the Nasdaq fell by the largest margins in months. Even worse, the Dow Jones fell by the biggest point drop in history. Experts at the Wall Street Journal believe that it’s likely due to higher bond yields, and that investors and fund managers are selling their equities for government or company debt, which caused an effect on the entire market.
Volatility has also soared on the CBOE Volatility Index (VIX), which measures expected swings of the S&P 500. Known as the “investor fear gauge,” the VIX is a forward-looking model that informs investors of how stable or unstable the market is. So if investors show signs of fearing market fluctuation, the VIX will increase. Uncertainty is rampant among investors, many of whom are exiting the stock market almost completely.
The fall in prices led stockholders believe that we are now entering a bear market after years of growth. Simply defined, a bear market is when the market is trending downward and encourages investors to sell, the opposite of a bull market. The name comes from the way a bear attacks an enemy: it goes up on its two feet and claws downward. Oppositely, a bull drops its head and lunges upward in correspondence to the market’s upward trend. This market is what the Charging Bull in lower Manhattan is representing. For the past nine years, the stock market has been regarded as bullish after the financial crisis in 2008.
People have begun to sell their stocks more and more rapidly, almost at panicking levels. Part of the speedy selling can be attributed to algorithmic trading and computer models that are programmed to balance risk assets. In fact, trading of exchange-traded funds blew up as the stock market fell. These financial assets act as marketable securities that track an index and make decisions according to the performance of the securities within index. In a way, it behaves like a computerized hedge fund manager.
However, the stock market may have reached its inflection point after these astounding valuation drops. According to Money Magazine, inflation is a contributing factor to the sell-off on Wall Street. As wages are rising and unemployment is at an all-time-low, consumers have more buying power and inflation is expected to increase. Now despite the significant corporate tax cuts, employees are now more expensive to their employers, which has a diminishing effect on their profit margins. Jim Paulsen, the chief investment strategist at The Leuthold Group, believes that these wage pressures will be more intense than most expect this year.
Among all the panic and unsettled nerves, many analysts and investment officers believe that the stock market is simply adjusting itself. In fact, some investors are receiving the price drop with open arms, professing it to be a “healthy pullback.” It allows investors to reevaluate and reorganize their assets and buy shares that they see as profitable at a lower price than before.
Few serious investors believe that the market will actually crash. If you view all of the recent valuation drops in a broader scope, they become much less alarming. The decline has only brought the market back to its mid-December 2017 level, only setting it two months back. Outside of the stock market, the economy seems to be faring quite well for consumers as wages rise and treasury bond yields grow. There is no sign of any economic distress, other than that of rising inflation.
The situation we have before us is surely an eyebrow-raising one, especially when news sources release headlines that indicate crisis and crash. High volatility and nose-diving stock prices seem to spell disaster, but the broader context presents a much more relieving picture. We have seen similar percentage drops in the S&P and Nasdaq before 2016 when the stock market was still on an upward trend, so the recent drops pose no significant threat. Although the news may be startling, it never hurts to stay calm and hold on.
Sources:
Driebusch, Corrie, et al. “Dow Drops More Than 650 Points on Worries About Inflation.”The Wall Street Journal, Dow Jones & Company, 2 Feb. 2018.
“VIX - CBOE Volatility Index.” Investopedia, 7 Aug. 2015.
Irwin, Neil. “Context Matters. The Stock Market Drop Is Less Scary Than It Seems.” The New York Times, The New York Times, 5 Feb. 2018.
Lim, Paul J. “The Stock Market Is Crashing. Here's What You Should Do | Money.” Time, Time, 5 Feb. 2018.
Otani, Akane, and David Hodari. “U.S. Stocks Waver After Wednesday's Rebound.” The Wall Street Journal, Dow Jones & Company, 1 Feb. 2018.
Otani, Akane. “Dow Drops More Than 1,100 Points in Stock-Market Rout.” The Wall Street Journal, Dow Jones & Company, 5 Feb. 2018.
