Wall Street isn’t ready for a 1,100-point tumble in the Dow industrials
By Mark DeCambre
The U.S. stock market has been
on such a parabolic march higher that Wall Street investors may have forgotten
what a typical, sharp downturn feels like.
Indeed, much has been made
about the lack of volatility. The CBOE Volatility Index VIX+1.78% otherwise
known as the “fear gauge,” had been flirting with its lowest close on record,
implying that market expectations for a sharp, sudden fall are near rock
bottom, as the Dow Jones Industrial Average DJIA+0.15% S&P
500 index SPX-0.13%
and the Nasdaq Composite Index COMP-0.12% scale
new heights. (The Dow notched
a fresh record on Friday to end the week 1.2% higher.)
The recent level of
complacency permeating the market has pundits talking about the lack of 5%
falls in the market—an occurrence that isn’t unusual in a normal market
environment. However, a 5% tumble, while normal, isn’t that common either. It
has occurred at least 75 times over the course of the blue-chip index’s,
according to WSJ Market Data Group, using data going back to 1901. The Dow,
however, hasn’t experienced a 5% decline since 2011, and before that a 5% drop
hadn’t happened since 2008, when there were 9 such drops (see chart below):
At this point, with the Dow
just 200 points shy of 22,000, a 5% selloff would equate to a 1,100-point,
one-day slide in the gauge. Is the market ready for that sort of sudden jolt
lower, given the optics of a quadruple-digit downturn and how it might rattle
investment psyche?
Art Hogan, chief market
strategist at Wunderlich Securities, doesn’t think so.
“I would say no because we’re
out of practice. Your usual standard garden-variety volatility just hasn’t been
around, and we haven’t seen it for 12 months,” Hogan told MarketWatch.
“Quiet markets have been the
norm and not the exception and I think a major pullback is going to feel a
whole lot larger for lack of experience and the numbers are larger,” he said.
Even a 2.5% drop in the Dow,
adding up a 550-point decline, could be unsettling, market participants said.
Those sorts of tumbles are far more frequent, with 564 such moves of that
magnitude occurring in the Dow since 1901. The most recent slump of at least
2.5% was on June 24, 2016, when the Dow
tumbled about 610 points, or 3.4%, a day after U.K. citizens voted to end
the country’s membership in the European Union. There were 3 falls for the Dow
of at least 2.5% in 2015.
Hogan said it is even hard to
imagine what the landscape of the market would like in the face of a plunge of
the same magnitude of the 1987 crash, when the Dow lost 22.6% of its value, or
508 points, in a single session.
“That’s why it is hard for
investors to think about it intuitively. We have no muscle memory for it. It’s
hard to harken back to 30 years ago. We have been lulled to sleep,” he said.
As for the S&P 500, going
back to 1950, 61 of the past 67 years have had a 5% downdraft at least once, or
91% of all years, according to Ryan Detrick, senior market strategist, at LPL
Financial.
“The inevitable 5% drop will
be a shock to nearly everyone,” Detrick said. “We’ve been historically spoiled
so far this year, but as the economic cycle ages, we fully expect more
volatility the remainder of this year and the likely 5% correction to take
place as well,” he said.
Market bears have offered no
dearth of warnings that a slide is imminent, including citing rich valuations
of the biggest names in technology, including Facebook Inc. FB+1.18% Apple Inc. AAPL-0.7% Google-parent
Alphabet Inc. GOOG+0.8%
, GOOGL+0.61%
Netflix Inc. NFLX+0.74%
and Amazon.com Inc. AMZN-2.48%
which considers itself online retailer rather than a tech behemoth.
Billionaire investor Howard
Marks, co-chairman of Oaktree Capital Management, said “this is time for
caution,” pointing to a
number of bad-market omens. Those include trailing 12-month
price-to-earnings ratios, a measure of valuation, for S&P 500 stocks
running at 25 times. He said another valuation metric, the Shiller Cyclically
Adjusted PE Ratio, known as the Shiller CAPE, is at its highest level since
only two other times in the market’s history: 1929 and 2000
On
CNBC on Thursday, Robert Shiller himself described the low level of
volatility in the market as concerning, saying he “lies awake worrying” about
how this period of quietude will last before things unravel. Though he admits
that it could run longer than academics, market pundits and bears might expect.
So far, investors have
demonstrated a preternatural resilience, shaking off political worries
associated with an expanding investigation into Russia’s ties to members of
President Donald Trump’s administration, infighting within that same
administration, and the unwind of easy-money policies around the world as the
Federal Reserve attempts to navigate its own efforts to normalize interest-rate
policy amid sluggish signs of wage growth, prices and inflation—key measures of
economic health.
When, not if, things go
pear-shaped, Detrick recommends that investors put the move into perspective:
“The important thing to
remember is the Fed is still accommodative, earnings continue to improve
globally, and inflation is contained—meaning any pullback could be a nice
opportunity to add equity exposure. Although a 5% correction might feel like
1987 to some of us about now, pullbacks and volatility are perfectly normal
parts of bull markets and are needed to flush out the weak hands.”
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