Dow’s plunge jolts markets
1,175-point loss is largest 1-day fall in index’s history
The stock market had itself a good old-fashioned sell-off Monday, as the Dow Jones industrial average fell nearly 1,600 points before closing at 24,345.75, down 1,175.21 points or 4.6 percent.
It was the biggest point drop in Dow history, but didn’t even crack the top 20 in percentage terms. Some considered it long overdue.
“This may turn out to be a blessing in disguise, although in the short term, it’s very painful,” said David Joy, chief market strategist with Ameriprise Financial.
After marching almost relentlessly upward for more than a year, the Dow tumbled 666 points on Friday after the government’s
January jobs report showed that hourly wages increased 2.9 percent year over year. That was better than expected and the strongest gain since 2009. Part of it was attributed to minimumwage increases that took effect in January, but it still stoked fears that the Federal Reserve would raise short-term interest rates faster than anticipated to head off inflation.
Going into the jobs report, traders were already edgy about interest rates. The yield on the 10-year Treasury bond rose from 2 percent in September to 2.4 percent by year end, then shot up to 2.84 percent on Friday, an unusually swift move.
Rising interest rates hurt stocks in two ways. As bonds yield more, they pose stiffer competition for stocks. And the present value of a company’s future earnings — a key component in how stocks are valued — goes down when interest rates go up.
“For a while there, the stock market was ignoring the bond market. With the yield moving up above 2.8 percent, the market took notice,” said Jurrien Timmer, director of global macro with Fidelity Investments.
Trading “started out fairly orderly” on Monday, said Randy Frederick, vice president of trading and derivatives with Charles Schwab Corp. “I thought it was going to be one of those typical pullbacks” where stocks close down on a Friday, “you get an early rout on Monday, then all the buyers step in. That’s how it looked until midday. Then all of a sudden panic set in. The VIX spiked sharply.”
The VIX is the ticker symbol for the Chicago Board Options Exchange Volatility Index. It predicts the volatility of the market over the next 30 days,
the Standard & Poor’s 500 index. Various products let traders bet on the VIX.
Up until Friday, the VIX had been one of the stranger things in the market. It had been eerily, almost spookily quiet as stocks set one new high after another.
All last year and up through Thursday, the VIX fluctuated in a narrow range, between 9 and 16. It jumped to 17.31 on Friday, and on Monday it exploded to 37.32.
According to Investopedia, a VIX greater than 30 is “generally associated with a large amount of volatility as a result of investor fear or uncertainty,” while a VIX below 20 generally corresponds to “less stressful, even complacent, times in the markets.”
A lot of short-term traders had investments tied to the VIX, betting it would remain in the doldrums. Many had borrowed money to finance part of their investment. When traders lose money on such leveraged bets, they often get a “margin call,” from their broker asking them to come up with more money, which often forces them to sell at least some of their position. That selling can exacerbate a downward spiral in a stock or the market.
Based on Monday’s trading pattern, it appears that many VIX trades were also computer driven, which can also lead to wild whipsaws in the market, partly due to automatic buyand-sell triggers.
Schwab is telling investors “to be very cautious about how this might play out” Tuesday, Frederick said. “We don’t think it’s over yet. Whatever buying came in (Monday) went back out.”
The Dow’s two-day losing streak totaled 7 percent and puts it in negative territory for the year, down 1.5 percent.
The yield on the 10-year Treasury actually dropped to 2.7 percent Monday as investors fleeing stocks snapped up bonds. When bond prices rise, their yields fall.
“This is an interesting indicator how the market might react to a political accident,” said Chris Wolfe, chief investment officer with First Republic Private Wealth Management. “It gives you a sense of how swift the markets can react.”
Before the two-day sell-off, stocks were costly by any measure. “They are still relatively expensive, but the (fundamental) backdrop is still sound,” Joy said. The economy is good, earnings are strong, and the recent federal tax cut “is positive for earnings going forward. To the extent that those things persist, this could be proved to be a fairly healthy thing for stocks. It knocks off some of the froth.”
Others fear the tax cut will provide fuel to an economy that doesn’t need it. “The tax cuts and fiscal stimulus coming nine years into an expansion, with the economy at full employment, there are consequences to that,” Timmer said. One is that the economy could be overheating. “That puts the Fed on alert to maybe raise rates more than the markets were pricing in,” he said.
Patrick Geddes, chief executive of Aperio Group, said there is a “real possibility” that volatility will intensify. “It was at historically, shockingly low levels. When that trips, it doesn’t do it gradually, it does it all at once.”
When this happens, “we get upset like everyone else. That doesn’t mean you should change” your long-term strategy.
“If you thought this shouldn’t happen, you shouldn’t be in the stock market. This is the nature of the stock market, to do things like this,” he said.