U.S. stocks slumped broadly last week. Here's why many stock investors are taking flight—and the case for staying calm
The Dow Jones industrial average was down nearly 400 points on Friday, pushing the Dow below 16,000 for the first time since last summer. It marked the 7th time in the fledgling year that the benchmark index had sunk by triple digits in a day, raising fears that the near-7-year-old bull market may be nearing an end.
Why the panic?
Wall Street seems to be focusing on the following three numbers:
Crude oil prices fell below $30 a barrel, hitting levels not seen since 2004. Falling energy prices are usually viewed as a bullish trend, as it lowers the cost of doing business for a wide assortment of industries, ranging from manufacturing to transportation. But oil prices can also be a foreshadowing signal—and in this case investors are worried that historically cheap crude is an ominous sign that global demand is far weaker than economists think.
Indeed, the last two times that crude oil prices even came close to piercing $30 a barrel was in 2008, amid the global financial crisis and Great Recession; and in 2000, when the bursting of the tech bubble pushed the U.S. economy into a recession.
The Producer Price Index, a key gauge of inflation at the wholesale level, fell 0.2% in December and sank 0.1% over the 12 months ended Dec. 31. No one wants rampant inflation. But the whole point of the Federal Reserve’s multi-year effort to stimulate the economy through near-zero interest rates and bond purchases was to create enough inflation in the economy to ensure that the economy doesn’t slip into a deflationary spiral.
Last week’s Labor Department report confirmed that the Fed may not have been fully successful at achieving its goal. And that, plus other disappointing economic data — including a report that showed industrial production fell by 0.4% in December — raises fears that the U.S. might well slip into another recession if the global economy continues to deteriorate.
After Friday’s 400-point plunge, the Dow was down about 12% from its 2015 highs, meaning the U.S. stock market is in an official “correction,” which is defined as a drop of 10% to 19.9%. The Standard & Poor’s 500 index is also off by about the same amount. This has triggered a new set of worries that the bull market that began in March 2009 could be on its way out. And that fear has led to even more selling.
But while Wall Street fixates on those bad numbers, investors should be focusing on this set of figures to put things in context:
Since 2009, this bull market has withstood five market pullbacks of near-equal or greater levels — and lived to tell the tale. Most recently, the bull lost 12.4% during the late August market slide which took place for the exact same reasons the market is jittery today — a combination of global slowdown fears and cheap oil. From those lows, though, the Dow climbed more than 11% through the end of last year, rewarding investors who hung in there.
The sell-off in the market has led to a new wave of bearishness on Wall Street. Why might some see that as good news? Wall Street is a counter-intuitive place, and peak market pessimism often coincides with the market hitting bottom—from whence there’s nowhere to go but up.
Have we reached that inflection point? Jack Ablin, chief investment officer for BMO Private Bank, studied the ratio of self-identified “bulls” and “bears” in surveys by the American Association of Individual Investors. The current ratio of bulls to bears is flirting with its lowest reading in the survey’s history, Ablin says, “which from a contrarian perspective is positive for stocks looking forward.” Historically, he notes, the S&P 500 has advanced 7.7% in the six months after reaching this level of bearishness. By contrast, stocks have historically gained only 2.7% in the six months following the most bullish readings among individual investors.
The odds of a rebound would certainly improve if the Fed leaves interest rates alone for the rest of the year rather than raising them four times in 2016, as some have predicted. And Ed Yardeni, president and chief investment strategist at Yardeni Research, says the market swoon makes it much less likely that all those rate hikes will happen. “Another year of one-and-done seems much more likely to us,” he says.
When the market is in full-blown panic mode, the CBOE Volatility Index—a.k.a. the “fear index”—approaches or climbs above a reading of 40. That’s roughly double the historic level. This happened in 2008, during the global financial crisis, and in the late 1990s, leading up to the 2000 tech wreck that triggered a global bear market. So far this year, the VIX has been on the rise. But at a reading of nearly 28, it’s nowhere near panic levels.