As I’m writing this post, the Dow Jones is down 300 points. Yesterday, January 29th, the Dow was down 177 points. Let’s keep this all in perspective.
Our friends at Dorsey Wright & Associates remind us the market typically generates a 5% pullback between three and four times a year on average, and the market also averages one 10% pullback per year, over now nearly 100 years, dating back to the 1920’s.
The Dow Jones has not seen a 1% drop in 111 days, one of the longest runs in history. We have been spoiled, as investors, because the market has not had a 5% or greater drop since the middle of 2016, now eighteen months ago. Even a 500 point drop (between yesterday and this morning) adds up to roughly a 2% drop.
Additionally, Tim has been reporting (most of January) in our daily meetings how over-bought the markets are right now. Historically (and in my memory), it’s hard to recall seeing a market get this skewed to the over-bought side. We have plenty of clients looking to get more aggressive, which is another (personal) indicator of this over-bought condition.
I say “clients getting more aggressive” is a personal indicator of mine, because I know the opposite to also be true: when markets are over-sold and there are bargains galore, no one wants to take the risk of buying. That’s when individuals (in general) want to “get conservative.”
So, how does an “over-bought” condition get resolved? Two ways:
- The market can simply go down.
- The market can “stall” and trade in place over a period of a few weeks.
Markets reach over-bought and over-sold levels many times, and markets correct themselves without folks even being aware of the underlying conditions. Again, Dorsey Wright has made good use of “bell curves” to help show neanderthals like me what over-bought and over-sold conditions look like. If some pictures are worth a thousand words, than this image below may be worth a million:
Believe it or not, this actually IS a bell-curve. It does not LOOK like a normally-distributed curve, does it? See how nearly everything is skewed WAY to the right? The right side is the “over-bought” side of the market.
And while you may not understand the symbols in the image, just look at the overall position of the symbols. Way over-bought, skewed far to the right side of the bell curve.
What is NOT over-bought? What is not over-bought (and in this case, over-sold) are areas like DX/Y (the US Dollar), and bond investments (IEF, AGG, SHY, LQD).
Now, by comparison, I have taken the exact same image and (very crudely) hand-drawn in where the actual bell-curve lies on this screen. Is it clearer now? Everything skewed FAR to the right side (the over-bought side). This is a market that needs to work off the over-bought condition. And, as written earlier, markets do NOT need to go straight down for that to happen. Markets can simply “jog in place” for a few weeks (or even a few months) to work that over-bought condition off.
And the area highlighted in yellow?
The area I have highlighted in yellow indicates the “normal” area of the bell curve. Nearly two-thirds of the time, the markets will “live” in this area (the fattest part of the curve). This is what a normal distribution curve OUGHT to look like.
Many thanks to our friends at Dorsey Wright & Associates for these images included in the post. The current market is over-bought. Again, there are two main ways to relieve an over-bought condition. First, the market can simply go down. Second, the market can stall for a period or weeks and months, and work off an over-bought condition that way.
What we missed in 2017 was volatility. We had one of the “quietest” years in recent history: very few big sustained drops, and not a single 5% drop at all in the calendar year. It’s normal to expect some volatility, and I suspect we will see our friend volatility return to the markets in 2018.
OK, one last bell curve for you (below), just to show the difference.
Below is a bell curve from October 1, 2008, nearly ten years ago.
Quite a different look, would you agree? Nearly all asset classes were skewed to the LEFT, indicating nearly everything was becoming very oversold. On the prior day (September 30, 2008), Congress had declined to approve the $700 billion TARP bailout package, and (after the news) the Dow Jones slid 777 points that day. Incidentally, for those keeping score at home, the Dow Jones closed at 10, 365 that day nearly ten years ago.