The Dow Jones Industrial Average lost 4.6% and suffered its largest-ever point decline at 1,175 on Monday — with the losses continuing to deepen in the overnight futures session, pushing the index down nearly 1,500 points to test its intra-day low. The catalyst was a continuation of the selling pressure seen on Friday related to inflation fears, higher bond yields and faster-than-expected wage growth.
But really, this is about long dormant volatility making a reappearance and shocking overly complacent investors. And boy, was it intense with the Dow Jones down 6.3% at its lows or nearly 1,600 points. The S&P 500 lost 4.5%, while the Nasdaq Composite lost 3.7%.
Adding to the intensity and fright of the decline were signs of stabilization near the open, with the Dow Jones actually moving into positive territory for a time as the situation seemed to clear. Then the selling intensified as the S&P 500 and Dow lost their 50-day moving averages. Large caps surrendered their gains for the year-to-date.
Every major sector group finished in the red, with the financials suffering the most (down 7%) pulled down by a 9.2% decline in Wells Fargo & Co (NYSE:WFC) after Friday’s supervisory decision from the Fed that growth would be curtailed until governance and controls were improved.
The selling pressure was overwhelming: Decliners outpaced advancers by a 9-to-1 margin while down volume swamped advancing volume by a 12-to-1 margin. This puts an end to the 410-day run without a 5% correction.
The ferocity of the decline, according to Morgan Stanley analysts, was a drop in market liquidity as computer trading algorithms fed on each other. Liquidity was down 50% in places from Friday, pulling down the average order size. That left a $3.4 billion sell side imbalance heading into the close, which is driving the after-hours decline.
What’s next? A relief rebound is in order.
Jason Goepfert at SentimenTrader ran the numbers a bunch of different ways after Friday’s pullback. And they look all look good.
Looking at the S&P 500 after a four-standard deviation selloff (which is what Friday was, amid low volatility) within a week of a new high? Stocks were higher a month later 90% of the time. S&P 500 suffering its worst week after a new high? Higher one month later 100% of the time. After ending a long streak without a 3% pullback?
Higher three months later 73% of the time.
Moreover, Friday featured record trading volume in inverse ETF products that win when the market loses (a positive contrarian signal). And the McClellan Oscillator, a measure of market breadth, fell into deep oversold territory.
Summarizing, Goepfert outlines a scenario based on market history: “Very generally, the pattern after most of them was a rebound in the very short-term, meaning the next week or so, another decline that tests the panic low (likely exceeding it), then a consistent rebound over the next three to six months.”
All of these measures have only gotten more extreme after Monday’s market dump.
What comes after the bounce? A further increase in interest rates as the economy heats up, putting the three-decade bull market in bonds on notice and raising the specter of further market losses. Edge subscribers are ready, enjoying a 33%+ gain in their iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX) position today.
Check out Serge Berger’s Trade of the Day for Feb. 6.
Today’s Trading Landscape
To see a list of the companies reporting earnings today, click here.
For a list of this week’s economic reports due out, click here.
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