Image shown: The SPDR Dow Jones Industrial Average ETF (DIA) share price performance since mid-2009. The pullback the past few days hasn’t amounted to much, but it has caught the attention of investors.
Recent equity market price declines don’t add up to much compared to the huge gains of recent years. Typical bear markets result in the evaporation of nearly 40% of investor wealth, on average.
By Kris Rosemann and Brian Nelson, CFA
The recent sell-off in equities accelerated in the trading session February 5 as concerns regarding an uptick in inflation (embedded in discount rates within valuation frameworks) and potentially materially tightening monetary policy in the US are weighing on investors’ minds. When the dust finally settled at the close of the session February 5, the Dow Jones Industrial Average (DIA) gave up 1,175 points (a 4.6% drop), while the NASDAQ (QQQ) and S&P 500 (SPY) fell ~3.8% and 4.1%, respectively, during the trading session.
Expectations for a return to more-meaningful levels of volatility in 2018 have come to fruition early in the year, perhaps far earlier than any had anticipated, and how investors react will be an interesting development, especially after considering news items such as reports of global pension funds hitting record levels as of the end of 2017. The CBOE Volatility Index (VIX) currently sits above 25 for the first time since June 2016. This measure is quite volatile, however, so it will move around quite a bit, but nonetheless, it is a good reading for tension that is building in equities.
Just about every sector of the market has been facing some form of selling pressure, and the energy sector claimed the title as one of the worst performers as the Energy Select SPDR ETF (XLE) fell ~4.2% in its biggest single-day decline on February 5 since January 2016. This followed a similar sized drop in the immediately-preceding Friday’s trading session, and US WTI crude oil (USO, OIL) sold off during the February 5 session as well, dropping ~2% to just over $64 per barrel. A stronger US dollar and rising US crude oil production are key factors in the group’s relatively poor performance.
But we have to remind you. The sell-off that has taken place during the past several trading sessions is really nothing in the grand scheme of things. The US stock market is up huge since the March 2009 panic bottom, nearly a decade ago now, and it has barely given back its gains for 2018, from just a month ago. It would have to take a shellacking to give back all of 2017 gains, but then again not really in historical context, and it isn’t out of the realm of reasonable possibilities, especially given market behavior in cryptocurrencies (XBT, GBTC). Bear markets usually result in about a 40% evaporation of wealth, on average. Concerns over inflation–and how that flows through the discounted cash-flow process in valuing equities–are material, and many a prudent investor may be more than willing to walk away from what had been a steady payout from the “casino” while they are still up, and up big.
Consumer favorites and Dow Jones Industrial Average components such as Coca-Cola (KO), Nike (NKE), Visa (V), McDonald’s (MCD), and Procter & Gamble (PG) have not been shielded from the selling pressure, and weakness in even the most steady businesses has led some observers to speculate over the role computer-driven selling has played in the acceleration of market-wide losses late in the February 5 trading session. Despite the sizable single-day sell-off February 5, investors must keep the big picture in mind. Again — the drop in the Dow February 5 only takes it back to levels from early December 2017! It is basically nothing. If you are worried about your wealth and can’t handle a 40% decline, as in typical bear markets, you should be thinking really hard about whether your risk profile truly matches that of having significant exposure to equities. Stocks aren’t fixed income vehicles with a payback period of your principle. Don’t ever forget this.
New Fed Chairman Jay Powell was sworn in the morning of February 5, but outgoing Chairwoman Janet Yellen made her presence felt before leaving office by levying a number of restrictions on Wells Fargo (WFC) following what the Fed has called “widespread consumer abuses and compliance breakdowns.” The sanctions will result in the replacement of three directors by April and another by year-end 2018, but perhaps the most meaningful sanction is the restriction of the bank in growing larger than its total asset size as of the end of 2017 until it makes sufficient improvements in governance and compliance. Shares of Wells Fargo are down roughly 8% in the February 5 trading session as of this writing, and many names across the financial space are also facing outsize pressure as a result of the sanctions.
In other corporate news, Broadcom (AVGO) has raised its bid for Qualcomm (QCOM) to $82 per share in what it calls its “best and final offer.” Broadcom’s previous offer was $70 per share, and the new offer requires Qualcomm to either complete its pending acquisition of NXP Semiconductors (NXPI) or terminate the deal. Shares of Qualcomm still sold off on the news February 5 and are trading just north of $60 at the moment. Takeover chatter regarding Archer Daniels Midland (ADM) and Bunge (BG) has resumed as well after Bloomberg reported the former is in advanced talks to purchase the latter, according to Seeking Alpha. Shares of Bunge have benefited from similar rumors in recent weeks.
Stocks aren’t the only financial asset class facing pressure of late, though Bitcoin has fallen significantly harder than equities as it has plunged below the $7,000 mark intraday February 5. Bitcoin’s bounce over the weekend proved to be nothing more than a “dead cat” bounce, it seems, and other cryptocurrencies are facing even greater pressure. The weekend ended February 2 marked Bitcoin’s worst weekly loss since December 2013. Several major banks, including JPMorgan (JPM), Citigroup (C), and Lloyds (LYG), have banned customers from making cryptocurrency purchases with credit cards. We hope you haven’t been caught up in the Bitcoin craze.
Other Volatility Indices: VVIX, VXGS, VXO, VXEFA, VXD, VXEEM, JYVIX, VXAZN, RVX, VXV, VXAPL, GVZ, VXGOG, VXIBM, TYVIX, VXEWZ, VXMT, VXXLE, VXFXI, EUVIX, VXGDX, VXSLV, EVZ, OVX, SRVIX, BPVIX
Disclosures: Kris Rosemann and Brian Nelson do not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.