In the last 25 years, according to CNBC, there have been 18 instances--including the decline on 2/2/2018-- where the Dow has dropped at least 500 points. Using Kensho Technology, CNBC analyzed what happened to the market after this type of decline. Typically, the Dow is up 2.83 percent one week after the drop and is positive 71 percent of the time. Of course, this may tell us nothing about what will happen next, but a drop of a little over 2% in the Dow is not that alarming.
Valuations and market sentiment have been euphoric and the Fed is no longer accommodative. That leaves intermarket trends and the growth in the overall economy as the only positive factors supporting the rise in stock prices. A one day drop in the Dow does not change the trend. Tops are processes that are historically formed over multiple market sessions.
Historically, long-term market tops are usually indicated by a deterioration in credit spreads and broad market internals (see the chart above). We illustrate the relationship between junk bonds and long-term Treasuries to show that risk preferences remain currently favorable. The cumulative advance-decline line of the NYSE (a dependable measure of market internal strength or weakness) also remains positive. Furthermore, the Dow and other market indices are still firmly above their 50, 100, and 200 day moving averages, which is suggestive of continued positive trends (see the chart above).
We would not be surprised if the recent decline started a run-of-the-mill correction. Besides, it has been over two years since we have seen one. Usually, we get at least one 10 percent correction per year.
A 2.5 percent decline is not a big deal. The trend is still up in most equity market indices and intermarket relationships still suggest a positive environment for risky assets. Furthermore, the economy is still accelerating upward suggesting this may simply be a flash in the pan. Until business cycle trends reverse to suggest taking a defensive posture, or trends in equities markets change, we maintain our positive outlook.
Investment Advisory Services offered through Sound Financial Strategies Group, Inc. (“SFSG”), a Registered Investment Adviser. Certain representatives of SFSG are also Registered Representatives offering securities through APW Capital, Inc., Member FINRA/SIPC, 100 Enterprise Drive, Suite 504, Rockaway, NJ 07866 (800)637-3211. SFSG and APW Capital are separate and unrelated companies.
The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by APW Capital.
Neither diversification nor asset allocation can ensure a profit or protect against a loss. Past performance is not indicative of future results.
Posted on Tue, February 6, 2018
by Sound Financial