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04 February, 2018 Education

The Not-So-Surprising Stock Market Selloff


The not-so-surprising stock market selloff

Stocks do sometimes still go down! Markets all around the world delivered this simple reminder this week including a -665 point in the Dow Jones Industrials on Friday resulting in a cumulative loss for the week of -1,096 points or -4.1%.

No Surprise

Daily Declines of -2% or More

Last 50 Years: 1 in every 40 days

Current Bull Market: 1 in every 41 days

This relative rough week wiped out more than half of the year’s strong gains. This decline wasn’t something I predicted, nobody can accurately predict such moves, but the selling did not come as a surprise. Consider that during the past 50 years the Dow Industrials has fallen by more than -2% in a single day approximately 1 in every 40 trading days or once every 8 weeks. Given that it had been more than 350 days, or nearly 9 times longer than normal!, since the last daily decline of this magnitude, it really should not have come as a surprise to investors.

There has been a lot of talk about the low volatility of the stock market in recent years. This has been true but it is also entirely normal for a bull market as stocks have consistently been less volatile when they are rising than when they are falling. Furthermore, if you measure volatility by the frequency of daily declines in excess of -2%, our current 9-year bull market has been entirely consistent with the past 50 years.

Forecast for the Future?

The logical next question is whether or not big daily declines provide some sort of forecast for the future and expected stock market returns. Certainly a single daily decline of -2.5% doesn’t suggest anything certain about the future. Friday’s decline this week was preceded by a -1.37% decline on Tuesday so the question becomes whether or not multiple large daily declines in a short period of time tell us anything. Again, there’s nothing certain.

During our current 9-year bull market, the Dow Industrials has two large daily losses within three days in September 2016. The Dow has gained +41% since then in less than 16 months. The same happened during Brexit in June of 2016. More interesting was in December 2015 and early 2016, the Dow Industrials fell more than -1% during 1 of every 3 trading days during a 45-day stretch. The Dow is up +63% in just over 2 years since that happened.

There is one example after another of daily volatility increasing and the bull market continues to rage on. Furthermore, a significant increase in volatility tends to be seen more often when stocks are hitting lows than when hitting highs in the cycle. The simple truth is that a daily selloff like we had on Friday, and even multiple daily selloffs that are close together, does not provide any reliable forecast about future stock market returns.

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