Equity markets began to sell off significantly Monday (1/27) after Friday’s (1/24) sell-off, which put equity markets in the red for last week. The S&P 500 fell 1.03%, the Dow Jones Industrial Average lost 1.23%, and the NASDAQ 100 fell only 0.35%, having enjoyed more upward movement earlier in the week.
The most recent market activity appears to be temporary and news-focused. Overall, the economic picture appears much rosier than it did in 2019. The yield curve inverted last year, but that event was coupled with fiscal stimulus, which is unprecedented. Typically, these two variables move together and have predicted each of the last seven recessions. However, when the yield curve inverted last year, fiscal stimulus heavily increased, which will likely reduce the probability of a recession. Additionally, recent weakness in manufacturing numbers has faded and productivity continues to increase.
A few intermediate-term concerns loom on the horizon, despite seemingly strong fundamentals. Sentiment is near all-time highs, which often means the market is overdue for a move downward. Sentiment movements tend to shift more frequently than significant economic variables, so any subsequent sell-off is likely to be short-lived.
While many news sources cite the outbreak of the new coronavirus in China as the reason markets have sold off late last week and early this week, there is a more technical and fundamental reason: The market has been on an upward tear for a very long time. We were in the third-longest period without a sell-off of 1% or more in the S&P 500 since the Great Recession. In short, we were overdue for some profit-taking by investors. While it has been a while since we’ve seen such market volatility, it is par for the course in equities in general.
Historically, when the market opens down more than 1% on a Monday, it continues its downward trajectory. If it does so on days later in the week, the market enjoys some mean-reverting behavior. Tuesdays and Fridays, in particular, tend to experience upward movement during the day. Today, we’re seeing the typical behavior for a Monday when the market opens down more than 1%.
Fortunately, the markets tend to rebound the next day after these events.
It may be tempting to make changes to an investment portfolio when this level of volatility arises. Investing in quantitative strategies can help take investor emotions out of the equation. Most of these strategies are designed with the long term in mind and aim to help investors navigate tumultuous periods such as these.