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An administration in a seemingly constant state of chaos, escalating threats with North Korea, uncertainty over Iran, the potential unwinding of NAFTA, the dismantling of key components of the Affordable Care Act…and stock markets continue to rise. The MSCI World Index of large and mid-cap stocks from 23 countries hit an all-time high on Friday, as stock indexes in the US, Japan, Hong Kong, Taiwan, Germany, the UK and New Zealand all reached multiyear or record highs last week.
October, month of crashes, has brought out the bears. It has been three long years since the broader indexes have seen downside moves of 10 percent and just like clockwork, here it is October and we have finally come close to the much-anticipated correction. The selling has been attributed to a slow churn of worry, which started with concerns about global growth stalling, especially in Europe and China. The fear is that just as the US economy has found more solid footing, the rest of the world might drag down the economy and corporate earnings to boot. In the week prior, investors vacillated between confronting those fears head on, and thinking that perhaps the Fed might keep interest rates lower for a longer period of time, which would help buoy markets. The “Fed to the Rescue” rationale may have limited the initial damage to stock markets, but the bears took control last week and dumped out of stocks and poured into the safety of bonds.
It is always scary to see and hear about big point losses, but context is important. On Wednesday, the Dow Jones Industrial Average dropped by more than 460 points, which seems pretty close to the 508-point loss that occurred on October 19, 1987. That day came to be known as "Black Monday" because those 508-points represented a 22.6 percent loss in a single session, the greatest one-day percentage loss Wall Street had ever suffered.
When the Dow was at its lowest level of the day on Wednesday, it was down just 2.8 percent. In fact, at current levels, the Dow would have to plummet about 3,700 points in one day to match the damage seen in 1987. And although the financial crisis of 2008 was more severe and dangerous to the entire financial system than the crash of 1987, Black Friday remains the most dramatic day of trading that most have ever experienced on Wall Street.
Still, the October action has spooked many investors, leading some to worry that a crash—or even a bear market, which is defined as a 20 percent drop over two months, could be coming. The S&P 500 has experienced 12 bear markets since the crash of 1929, most of which occurred in, or around, economic downturns. According to Capital Economics, the current sell-off is unlikely to mark the beginning of the dreaded 20 percent drop, because bear markets do not normally occur in the middle of entrenched recoveries. “There’s nothing in the US data that has fundamentally altered our view on the outlook for the domestic economy…the near-10 percent fall in equity prices has sparked fears that something more pernicious lies ahead. But that drop in equity prices looks out of kilter with the health of the economy.”
Of course market drops could certainly wipe out a portion of household wealth, which may curtail consumer spending and hurt growth. But energy prices have plummeted alongside sagging stock prices and the net effect of lower prices at the pump should more than make up for the hit to the wealth effect from stocks. Still, for those who are worried that a crash or the next bear market is around the corner, the following aphorisms might be worth revisiting:
MARKETS: It was a topsy-turvy week, which caused the volatility index (VIX) to surge to a 2014 high of 31.06 on Wednesday. By Friday, the VIX dropped to 22, a lot closer to its long-run average of around 20, but twice as high as the July low of 10.32 and up nearly 74 percent from a month ago.
THE WEEK AHEAD: With stock markets wobbling, bond prices are rising, yields are falling and rates for mortgages are tumbling to the lowest levels in over a year. The housing market could use a boost, but the recent drop in rates will not provide any help until next month’s data are released.
Mon 10/20:
Apple, Halliburton, Hasbro, IBM, Texas Instruments
Tues 10/21:
eTrade, Harley Davidson, Kimberly Clarke, McDonald’s, Verizon
10:00 Existing Home Sales
Weds 10/22:
AT&T, Boeing, General Dynamics
8:30 CPI
Thurs 10/23:
3M, Amazon, Microsoft
8:30 Weekly Jobless Claims
Fri 10/24:
Colgate, Ford
10:00 Existing Home Sales
