February 6, 2018

The major stock market averages are very choppy in early trading. At the moment, the Dow is down 165 pts and the SPX is down .7%. Materials and Consumer Discretionary sectors are in the green, but most of the rest of the market is down again. And European markets, by the way, are poised to close 1.5%. The VIX Index is all over the place, having surged about 90% yesterday and fallen 30% today. It is now trading at 25.8. Not coincidentally, the last time the VIX spiked so high was August 2015 in concert with the last flash crash. Treasury bonds are falling in price as yields resume the march higher. The 5-year and 10-year notes are trading at 2.49% and 2.76%. Junk bonds, however, are faring well today. The SPDR Bloomberg Barclays High Yield Bond ETF (JNK) is up .25%, and that’s really good news, suggesting investors aren’t worried about credit. 

Yesterday, the Dow and SPX fell more than 4% in a wildly volatile session. That left the SPX 8% off of its recent peak, and erased January’s positive return. Trade volume was very high. At one point during the session, within 20 minutes the Dow went from down 800 to down 1600. This was clearly a flash crash driven by the machines. Importantly, market weakness isn’t being driven by bad earnings announcements or a softer economy. That’s why gold didn’t explode higher. The pullback very quickly reset stock valuations. The forward P/E ratio on the S&P 500 Index fell from 18.5 to 16.9. And the SPX hasn’t traded at that level since November 2016. 

The consensus Wall Street view is that this is a nothing more than a correction (probably amounting to 10%) in the context of a continued bull market. This does not call for panic. Long-term investors don’t need to time the bottom exactly but can use weakness as a buying opportunity. Tony Dwyer of Canaccord Genuity says the only time you want to get “sustainably negative” is when the Fed inverts the yield curve and chokes off credit. As long as you have credit flowing and money availability and earnings per share in the right direction” you can still invest with confidence.  

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