A Quick Note About the Recent Sell Off

February 6, 2018, by John Norris

Is it time to panic?

Unless you really don’t digest any financial news, you know the stock market has been taken a beating over the last several trading sessions, a bad one. The last hour or so of trading yesterday was about as painful as it gets, almost begging the question: is this 2008 all over again?

As I type this, I would answer that question pretty emphatically no. However, that doesn’t mean the markets won’t give us a little more heartache before finally settling down.

It is hard to quantify just how much of the recent unpleasantness is due to the (pardon me Alan Greenspan) irrational exuberance we had in January. Frankly, it was ridiculous how hot stocks started the year, and no one in their right mind thought it was going to last. In other words, what goes up has to come down. I just wish it didn’t have to be so painful.

The industry has been throwing around a lot of reasons for all the recent red ink, and they make sense to some small degree. Recent wage gains and a tight labor market could spur wider consumer inflation, causing longer-term interest rates to climb and the Federal Reserve to be more aggressive in raising the overnight lending target. That is arguably the most popular one. However, I have also seen a fair amount of commentary about how this sell-off is more technical related that anything else, and the ‘quant guys’ have been blowing things up. If you understand short-term trading behavior, this also perfect sense. Finally, when all else fails there is the old tried and true: stock valuations were/are too high given the overall level of corporate profitability. Perhaps, or perhaps we have heard this for so long we accept it as truth without really thinking about what it means.

There are others, but there is a common thread running through all of them. We are going to have to pay the piper for all the good stuff that has happened to us recently.

Consider the first argument. Let me rephrase it for you using the markets’ current psyche: “All hell is going to break loose because more people have better paying jobs than they did and the economy is stronger than it should be at this point in the cycle.” The horror! Lock the doors! Then there is the other one: “Stock prices have to go lower because we had too many buyers at the higher price.” Like that one? I think it a good one.

Here is what is going on: an increase in long-term rates to still low absolute levels was a wonderful justification for certain speculative investors to reduce their overweight long positions after an overbought (to the bought of lunacy) January. The sell orders swamped exhausted buyers, and prices dipped below technical support levels…which were frankly pretty weak because stocks had gone in only one direction, up, for a while. Program trading kicked in after that, creating something of a perfect short-term storm.

But how long will it last? That, my friends, is the $64,000 Question.

Being the ‘glass has water in it’ type of guy I am, I would suggest the markets generally come back to economic activity and the prospects for it. When economic activity is projected to go up, so too should corporate profits and stock prices. Obviously, the inverse is true.

As I type, and with all the data I have absorbed, it would be really hard for me to forecast an economic slowdown in the near-term significant enough to engender another 2008 or even 2002. In fact, the overall economic data is currently as solid as it has been for the last decade, seriously. As such, while incredibly uncomfortable, the recent sell-off should be relatively temporary until the ‘quant guys’ find their necessary support levels for both stocks and bonds. Is that a trading session? Two trading sessions? Three? Now, that is hard to tell.

In the end, what I can tell you is this: as incredible as this might seem, at this time, there doesn’t appear to be anything fundamentally wrong with the US economy which would suggest a need to drastically change your/our asset allocation.

That is a nerdy way of saying: there ain’t no need to freak out. Trust me/us, when that time comes, you will know about it before it happens.

Take care, have a great day, and watch something other than the business channels.