Market Sell-off Thoughts 2/24/2020

The Dow traded down over 1,000 points and finished with the second largest single-day point decline in history. The largest point decline occurred two years ago, on Feb. 5th, 2018 when the Dow declined 1,175 points. While the point total was high, today’s sell-off isn’t in the Top 10 in the more relevant percentage terms. The biggest single-day drop in Dow history occurred on Black Monday, October 19, 1987 when it declined over 22%. So, what’s going on today? Most of the headlines have blamed a growing fear over the inability to contain the coronavirus. I believe that’s partially correct, but not the full story.

Coronavirus is a concern, and cases are appearing around the globe. The US has 34 confirmed cases and a large outbreak is starting in Korea. Over the next few weeks, we could start to see product shortages on goods made in China and other places. This will slow economic growth in the this quarter and could carryover into next quarter. However, I don’t see this a long-term problem. Researchers will find effective treatment and/or a vaccine. Additionally, when the supply chain is back up and running, pent up demand will likely help fuel stronger than trend growth later in the year.

Interest rates are another area of concern. I wrote about the 10-Treasury rate dropping below 1.50% last week in the weekly recap. In addition to the US rates, many parts of Europe and Japan are seeing some negative interest rates. That means that investors are actually losing money to buy these bonds. Many buyers of sovereign debt aren’t yield sensitive for various reasons, but seeing US rates trend towards Europe and Japan suggests many investors are nervous for future economic growth. It’s important to note we’ve seen similar moves in rates during the Greek debt crisis, the Cyprus banking sector collapse, Brexit and several other inflection points over the last decade, but growth has generally continued higher. I think the economy is still reasonably strong right now and this move in interest rates seems overdone and not predictive of an upcoming recession.

Another important factor in days like this is quantitative trading. Many hedge funds build complex algorithms that dictate trading. These programs have automatic sell orders built in based on a variety of factors. Certain stocks drop by a certain percentage and the programs sell. If indices drop by a certain amount, the programs sell. This can lead to a selling begets selling situation. As stocks keep declining, more programs trip requiring more selling. This can push a mediocre down day into a full-blown sell-off like we witnessed today. These days happen. They are never fun and sometimes the sell-offs continue for several more days or even weeks. While it’s impossible to know what the future holds, every time we’ve had a sell-off like this over the last decade, they’ve been short-lived and stocks eventually kept moving higher. 

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