Why the Stock Market Is Down–and What to Do Now
That
is finally dropping, something investors should have seen coming after five months of gains. Now it’s time to ride out the storm.
It certainly has been a stormy week for the stock market. The
has dropped 1% on Tuesday, on pace for its largest decline since February. And for once, it feels like there is almost no place to hide. Three S&P 500 stocks have fallen for every one that has risen, and only two sectors—energy and utilities—are higher on the day. There’s no rotation here. The
or VIX has climbed 11% to 15.10, its highest since March 11.
Blame rising bond yields for the decline in stocks. The 10-year Treasury yield ticked up as high as 4.39% on Tuesday, before slipping back to 4.373%, but is still at its highest level of the year. What’s more, bond market volatility, which had been quiet of late, has suddenly returned. The Merrill Lynch Option Volatility Estimate, or MOVE Index—the bond market’s version of the VIX—rose 9% on Monday, its biggest percentage move since Jan. 2.
The stock market doesn’t want to see interest rate volatility. Historically, stock and bond market volatility has been closely correlated, according to 22V Research. Given where the move index is right now, the VIX could easily be higher. That’s especially true given that the
gain relative to its volatility, known as a Sharpe ratio, has been above 4 for the past six months, according to Citrini Research, conditions that are almost too good to be true. “I’m not bearish but that’s relatively unsustainable, I think, and I would not be surprised to see a natural pullback to recent SPX highs,” writes James Van Geelen on the Citrini Research substack.
Now, the question is whether a correction—defined as a 10% or greater drop—is beginning. It wouldn’t be a surprise if one were. After all, a correction has occurred in the majority of years dating back to 1980, according to Dow Jones market data. What’s more, the S&P 500 is up about 26% since a low point hit in late October, and some technicians have warned in recent weeks that the market has come too far too fast. And with the index trading at 21 times 12-month forward earnings— high relative to the profits—any disappointments when earnings season starts next week could cause stocks to fall.
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Another risk is that the Federal Reserve may not cut interest rates as many times as the market currently anticipates, something that would keep rates at elevated levels and could ultimately slow down economic growth.
The technicals are not comforting. The S&P 500 has fallen close to its 20-day moving average of 5178, a signal that it’s losing momentum, and could continue to fall. “Be vigilant when equities violate their 20-day moving averages,” writes Craig Johnson, chief market technician at Piper Sandler. “The weight of the technical evidence indicates the S&P 500 is vulnerable to a 5-10% pullback/correction in the coming weeks/months.”
So what should investors do now? Nothing. Buying more might not be a great idea—yet—but holding on to the index is. The economy is still growing and companies can still grow profits. The Fed almost certainly won’t be hiking rates. The stock market may just have to dip in the near-term, before resuming a long-term advance.
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“We view those pullbacks and consolidations as a healthy sign within the context of the current intermediate-term upward channel,” Johnson writes.
The market isn’t a buy or a sell. It’s a hold…until it becomes a buy again.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
