Don’t Panic: The Market Decline

2/6/2018 - The previous couple of days have been volatile given the recent market decline. Within the past few days (Jan 26 -  Feb 5) the market fell nearly -8%. On Monday (Feb 5th) alone the S&P 500 fell -4.1%.

S&P 500 since Jan 2017

If you watch CNBC, read Yahoo Finance, or consume any other financial media, the reasoning behind this sharp downturn is likely to be due to "inflation fears," "geopolitical instability," "central bank tightening," or even "a fat-finger on a trading desk spurring a massive sell-off."

I suppose these could all be factors, but I find it hard to believe that these fears are suddenly manifest when last week they were only minor concerns. Instead, I would like to offer another explanation. Perhaps the stock market is going down simply because it went up for too long. Yes, I know this isn't a sophisticated answer and it's probably an answer you weren't expecting. But not all answers have to be complex and difficult to understand. The S&P 500 was incredible in 2016 & 2017 as it climbed the wall of worry and it did so with nearly no declines. Market volatility was essentially non-existent despite high valuations.

VIX since Jan 2016

I believe the past few days to be a garden-variety correction. And keep in mind that a market correction is defined as -10% pullback. It may not feel like it because this has been a sharp decline. The difference in today's market vs. those in the past is that the market simply moves faster than it has in the past. And for those of you that follow my investment philosophy, you know that I believe this is due to accelerating information diffusion (the speed at which information spreads throughout the marketplace). The crux of this idea is that investors are better informed because everybody is better connected. This leads to a more efficient market where managers that attempt to outperform benchmarks rarely do so. And thus, market declines are sharper.

I spoke to a very good friend and finance colleague about this yesterday and I believe he said it best, "This stock market selloff the past few days is price discovery with a splash of overshoot." Perhaps overshoot is an understatement. A generous pour is more like it.

Is the market selloff done? Maybe. I don't know. The market recovered a bit today, but one day does not make a trend. Keep in mind that the stock market just had a record-breaking year. The fundamentals within the overall economy have not changed so I would be hard-pressed to think that this correction will turn into the "big one."

Ryan Hughes
Bull Oak Capital
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