After the financial fallout of last week, the big question everyone should be asking (and I’ve asked it myself) is: how do I change my investment strategy as a consequence?
Before I answer this question, let’s recap on the big revelations of the week. I think we should look at it all via the following questions: What happened? Why did it happen? What will happen?
Here are the facts of what happened
- The S&P 500 Index lost about 5.2% last week but is down around 11% since January 26.
- The S&P 500 actually travelled about 22,000 points across the week. This is volatility like I’ve never seen before!
- Both indexes have erased 2018 gains even after clocking their best starts to a year in January in some time. It was the Dow's best January since 2013 and the S&P 500’s best since 1997.
- The sell-off began Friday week, February 2, when the Dow fell 666 points after a better-than-expected jobs report and a solid wage rise number ignited inflation fears. That fall was exacerbated last Monday after the yield on the benchmark 10-year Treasury note hit a 4-year high, sending the Dow tumbling another 1,175 points, as investors grew more nervous about an overheating economy
- The Dow might have lost 5.2% over the five days of last week but January 2016 was worse. So, we have been in similar situations and the market was able to march higher. However, since January 26, it’s down 9% but, before Saturday’s close, it had been in correction mode down over 10%.
- The Dow’s loss last Monday was the biggest point-drop in history, losing 1175 points on Monday, wiping out all the 2018 gains!
- On Friday, the Dow surged on a 300-point rebound into the close, which is a positive sign.
- The CBOE Volatility index (VIX) — the market's best fear gauge — shot above 40 again Friday after jumping as high as 50 earlier in the week. At the end of January, the VIX was below 14, which says fear has retreated.
And why it happened
- The S&P 500 index in January hit its 10th consecutive monthly gain, the longest streak in 59 years but a correction was way overdue
- The trigger for the sell-off was rising interest rates in bond markets because of better-than-expected employment and wage data that sounds the warning bell on US inflation.
- Hedge fund managers and short sellers thrive on these unstable, volatile times and it’s when they make their money. So, they buy and sell stocks, bonds, currencies for all their worth to take advantage of market instability. And remember, they’ve had some rough years lately, with stocks in most markets trending higher most of the time.
- Exotic ETFs linked to the VIX or ‘fear index’, along with algorithmic trading, increased the volatility and accentuated the falls. During the week, Fidelity banned it retail investors putting their money into their VIX-related products. One crazy product fell about 85% in after-hours trading Monday, prompting the issuer, Credit Suisse, to say it would end trading in it after February 20!
- Goldman Sachs' Peter Oppenheimer warned clients on January 29 that correction signals were “flashing” and advised clients to prepare for a correction. "Our Goldman Sachs Bull/Bear Market Indicator is at elevated levels, although the continuation of low core inflation and easy monetary policy suggests that a correction is more likely than a bear market," Oppenheimer wrote.
Of course, he wasn’t alone, and regular readers would know I’ve said many times that we should expect a pullback in 2018 because the gains on the US stock market since the election of Donald Trump have been extraordinary.