Ouch. It was the biggest drop in the Dow Jones Industrial Average since August. Markets tumbled yesterday, while fears surged—about jobs, Spain and Saudi Arabia.
But what does this mean for you, the investor?
Was this just a one-day wonder, a buying opportunity, a small but passing cloud on an otherwise sunny horizon? Or was it something more ominous?
The market's next move is always a mystery. It could go up 500 points next week or down 500 points, or stay in range. You shouldn't let one day's price movement govern your financial decisions. It's never sensible to panic. And sure, this could be just a passing storm.
Yet there are reasons to be concerned about what just happened. Maybe I'm being too nervous here. I hope so. When the market sells off, I usually like to find reasons to buy stocks more cheaply. But here are 10 reasons why this 228-point slump in the Dow makes me sit up and take notice.
1. It happened when the price of oil was falling.
For weeks, the market has been worried that the rising price of oil was going to knock the economy back into the hole. But the price of light sweet crude fell $2 a barrel on Thursday to $102. That followed a $1 fall earlier this week. It's still above the critical $100-a-barrel figure that may spell economic trouble. Nonetheless, some relief on oil should have been good news. If the market sells off at the same time it suggests investors may be reevaluating the fundamentals of the recovery.
2. It was across the board.
It wasn't just isolated to a few exchanges here or in Europe or in the Middle East. Exchanges fell around the world. Wall Street was down 1.9%. Shanghai and Tokyo both fell about 1.5%. Brazil's Bovespa was down 1.8%. London fell 1.5%. Even gold fell. The Standard & Poor's 500-stock index is now down about 4% from the peak seen last month. Since then it's tried three times to get its mojo back, and it's failed each time. Not cheerful.
3. The financial cockroaches are back.
The European debt crisis. Our continuing jobs gloom. Oh, and let's not forget the rocketing national debt that is financing the entire stock-market boom. In past months I've been watching with amazement as Wall Street—and a lot of investors—have been trying to sweep these under the carpet. But they won't stay there. On Thursday, markets were spooked when Moody's downgraded Spain's government debt. But why is anyone surprised? The market for default risk was already sending serious signals that Spain and Portugal may default. And it has all but given up on Greece.
4. One of the smartest bulls I know has suddenly turned very edgy.
He's a European hedge fund manager who turned bullish in January 2009—on high-risk financials, no less—and has stayed upbeat for most of the past two years. He was a raging bull last summer. Even a handful of weeks ago, he thought we'd see more momentum. Today? He's singing a slightly different tune. One of his biggest worries now is China—in particular the strength of its economy and its sudden, surprise trade deficit last month. He's still looking for opportunities, as always, but I thought he'd be buying aggressively in this correction. He isn't. (Another manager I know thinks there is some juice left in the rally, as first-quarter earnings roll in. But she expects to turn more cautious after that.)
5. The bull market has just come so far, so fast.
Too far? From the lows of two years ago, the S&P 500 has almost exactly doubled. By any measure, it's been a remarkable boom. The Russell 2000 index of smaller stocks has soared 130%. So has the S&P Mid Cap 400 index of medium-sized companies, taking it to a new record high. But look at the fundamentals. Over that time economic growth has been sluggish. The economy today is no bigger, in real terms, than it was three years ago. The true jobs picture remains a disaster, and far worse than the official data will tell you. Wages have been stagnant. Yes, companies have boosted profits—to near-record levels—by slashing costs. But how far can that take you? (Perhaps in the end there will just be one, very productive guy left with a job. It would be Apple ( AAPL: 353.56, +1.57, +0.44% ) 's Steve Jobs, of course. But then, alas, he'd have to buy all those new iPads himself.)
6. There's no "margin of safety" left in stocks.
While Wall Street was backing off a cliff Thursday morning, I was interviewing one of the brightest and most original thinkers in the market—James Montier, strategist for tony fund shop GMO and author of "Behavioral Finance." Mr. Montier pointed out that stocks are now so expensive, they leave investors with almost no "margin of safety" in case things go wrong. Anyone investing now, he said, is taking a big bet on sunny skies and plain sailing ahead. It can happen, but life is not always so kind. "We're not completely 'priced for perfection,' but we're not far off," Mr. Montier said. And, he added, the risk curve was wrong as well: Based on GMO's calculations, investors in small-cap stocks at these levels actually face worse returns than investors in large-cap stocks. As small caps are more volatile, they should offer better returns to compensate. (My full interview with Mr. Montier will be published on MarketWatch on Monday.)
7. Wall Street looks unappealing by the numbers.
The dividend yield on the S&P 500 is well below 2%. According to data compiled by Yale economics professor Robert Shiller, stocks are a thumping 24 times cyclically-adjusted earnings. That's extremely high. The historical average is about 16. In the past, today's levels have been associated with bubbles and hot markets, and have generally been followed, sooner or later, by a correction. A similar conclusion is reached by comparing equity prices to the cost of replacing company assets, a metric known as "Tobin's q." It also says Wall Street is heavily overvalued. Maybe worst of all: It is just extremely hard to find any cheap stocks out there. If I saw some great bargains, I'd say, "Don't worry about the market, buy this terrific company on six times earnings." But these types of opportunities are so thin on the ground right now. No one measure has all the answers. But plenty of metrics are signaling, at least, caution.
8. The public was just starting to buy stocks again.
Oh, brother. The U.S. private investor, who spent most of the 2009-10 rally getting out of stocks, started piling in again earlier this year. According to the Investment Company Institute, investors cashed out a net $31 billion from equity mutual funds between the start of March 2009 and the end of last year. But since Jan. 1, they have shoveled a net $33 billion back in. History has frequently shown that the public gets in—and out—at the wrong times, buying near peaks and selling near troughs. Is it happening again? I wish I felt better about this.
9. The insiders have been getting out.
Executives and directors across the market have been cashing out stock at a fast clip. "The pace and volume of insider sales hit a four-year high during Q4 '10," reported InsiderScore, a firm that tracks such data. While many of the top brass may have been locking in capital gains before a possible tax hike in 2011, it said, the pace of insider selling actually speeded up after the December tax deal, which gave a last-minute reprieve on taxes. And that suggests "it was valuations and opportunity—not the Taxman—that were the main catalysts for the record surge in insider selling," said InsiderScore. "Each sector and market cap group experienced heavy selling." So far this year insider selling has remained at a strong pace, too.
10. Sentiment had become giddy.
Jim Cramer on his TV show "Mad Money" has on occasion recently decried "all the negativity that's out there." I like Mr. Cramer, with whom I once worked, but he must be hanging out with an unusually gloomy group of people. I can hardly see any bears anywhere. They're in hiding from a two-year-old bull. As reported here not long ago, fund managers had turned downright euphoric about the stock market. Hedge fund managers are now once again betting heavily on rising stocks—and rising oil—with borrowed money. Equity analysts have been hiking their forecasts. Oh, and the hot stocks were back—like Salesforce.com ( CRM: 124.94, -2.93, -2.29% ) , which recently hit 100 times forecast earnings. That's a hefty multiple for an $18 billion company. Whether Salesforce stock turns out well or ill over the longer term, you can hardly deny that its investors are cheerfully—some might say remarkably—optimistic.
None of this is a reason to start panicking. But these are grounds for investors to be cautious.
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