• The Dow Jones Industrial Average posted its largest-ever, single-day point decline yesterday.  Major indexes in the U.S., Europe, and Asia have given up their gains for the year.
• As of the close of the market last night (Feb. 5^th), the Dow has lost 8.6% from its high on January 26^th.  The Dow is now down 1.5% since the beginning of the year.
• Today, US equities are volatile again.  The last time the S&P 500 dropped by this amount was almost 3 years ago when the Chinese devalued the Yuan in August 2015.
• The analysis I have read points to 3 reasons for this sudden decline in stock markets:
  • Inflation gauges have increased lately and the fear of both wage and price inflation in the U.S. has been one impetus for this sell-off.
  • Intermediate term interest rates have increased significantly in the past 2 weeks.  Concerns that the Fed will hike interest rates further to fight inflation are also causing investors to sell.
  • Many institutions and hedge funds have invested on margin (borrowing money to buy stocks) and are now facing margin calls.  Additionally, program trading (computer driven strategies) weighed heavily in yesterday’s sell-off.
• While this sell-off is significant—in fact it is now approaching the 10% correction threshold—underlying economic data is still very strong.  Specifically: 
  • Unemployment is very low
  • Both the Services and Manufacturing parts of our economy are still expanding
  • Corporate earnings have surged in recent weeks.  70% of companies are reporting higher earnings than forecast. 
  • Of the 28 different economic indicators released on the previous 10 days, 14 have been stronger than expected and 9 have been in-line with expectations.
• What should we expect over the next 1-3 months:
  • While I am relatively optimistic that the current correction in stocks is not the end of the world, but simply a re-rating on valuations and a check on momentum, further lows are likely.  The U.S. stock market is in a long-term topping process and an instant bounce back to new highs should not be expected.
  • In three previous historical examples that parallel the current situation, markets continued to be volatile for several months after the initial sell-off.
  • In the Flash Crash of 2010, the debt ceiling chaos of 2011, and the Chinese Yuan revaluation of 2015, stocks initially ‘crashed’, then were volatile for several months.  The market lows were finally reached 1-3 months after the correction began.
• If markets follow historical examples, we should see significant volatility over the next 1-3 months.  Markets may even go a bit lower. Usually, markets stabilize after several months of volatility and begin a new upward trend as long as economic data remain supportive.

Sam Sweitzer, CFA │Principal│ANSON ANALYTICS, INC.│