The big news as I write this is that the stock market is down more than 1 percent. That translates to more than 200 points for the Dow, 30 points for the S&P 500, and 80 points for the Nasdaq.
Looking at the screen, I see nothing but red. Ouch.
Drop seems scarier than it is
This drop is particularly painful given how long it’s been since we saw any volatility. The markets have essentially bounced within a narrow range since early July, so we've gone two months without experiencing any turbulence.
Of course, the past two quiet months have been an aberration; we don’t have to look too far back to see some real volatility. At the end of June, there was a much bigger pullback, with the S&P 500 down 113 points, or more than 5 percent. At the start of the year, we saw a drop of 281 points on the S&P, or 13 percent, from the late-2015 high to the mid-February lows.
In context, then, today’s drop is normal. As I write this, we’re down about 43 points from the high in August, or less than 2 percent. We’ve seen this kind of decline several times in the past couple of months, albeit over a couple of days rather than one.
That isn’t to say it won’t get worse; it might. But we do need to distinguish between normal moves and those that warrant our attention. This drop isn’t there yet—not even close.
Probably the usual September volatility
With investors returning to the office from August vacations, catching up on the news and considering how to prepare for the end of the third quarter and the start of the fourth, September has historically been the worst-performing month of the year. I said as much in my September market preview, for exactly those reasons. What we're seeing now is in line with history and with market expectations.
Big drops are scary, which is why it’s important to have that historical and fundamental context. Personally, I start to pay attention when the markets get close to their 200-day moving average. For the S&P 500, that's around 2,060; for the Dow, it’s around 17,600. That means I’m not going to worry until we lose at least another 70 points for the S&P, or about 640 points for the Dow, which would be another 3–4 percent for both, bringing us down a total of just over 5 percent.
That may sound like a lot further to fall before we start worrying. Shouldn’t we pay attention before that? We certainly could, but the 200-day line is where the probability of a more severe drop becomes material. Before that, chances are strong that the decline will reverse itself.
Plus, fundamentals remain solid
As I wrote the other day, any September volatility should be cushioned by strong fundamentals. Consumers remain both able and willing to spend, despite weakness in business sentiment data. Arguably, any pullback this month would be a rational response to that weakness, rather than something much worse.
We will see. In any event, the real economy, which ultimately drives the financial markets, continues to limp along. As my market risk analysis showed yesterday, immediate risk levels remain low and are even improving.
I’m certainly not enjoying today’s market theatrics, but I’m not particularly concerned either. So far, at least, the markets are acting normally and as we might expect.
Right now, the biggest risk investors face isn't volatility but the urge to overreact to it. Keep calm and carry on.
Brad McMillan is the chief investment officer at Commonwealth Financial Network, the nation’s largest privately held independent broker/dealer-RIA. He is the primary spokesperson for Commonwealth’s investment divisions. This post originally appeared on The Independent Market Observer, a daily blog authored by Brad McMillan.
© Commonwealth Financial Network
