July 27, 2021

The Stock Market Just Got Creamed. Here’s What to Do Now.

It’s been a bad week for the stock market—real bad. But is it bad enough to sell and run away?

On the surface, it sure feels like it. The Dow Jones Industrial Average declined 943.24 points, or 3.4%, while the S&P 500 fell 3.5%, and the Nasdaq Composite, home to supposedly safe stocks such as Apple (AAPL) and Amazon.com (AMZN), dropped 3.7%. Almost no one was spared, as just 15 stocks in the S&P 500 managed to finish higher on the day. Ouch.

If it were only one day, the selloff wouldn’t be so worrisome. But the Dow has fallen for four consecutive days and is now down 8.9% from its Sept. 2 high. The S&P 500 is off 8.7% from its all-time high, and even the Nasdaq Composite has fallen 8.7% from its record high. Again, no one is being spared.

With a market correction—defined as a 10% drop—so close, selling feels like a real option. If the S&P 500, for instance, drops through 3200, it could fall to 3000, which would be a 16% drop from the high. Not quite a bear market, but still.

The drop, however, may simply be a necessary corrective before the election arrives. Brad McMillan, chief investment officer at Commonwealth Financial Network, notes that optimism surrounding Covid-19 and the economy had probably gotten ahead of itself. The recent slump more likely reflects what’s happening in the world. “What we are seeing now is a reality-based repricing,” McMillan writes. “As such, this drop is both necessary and healthy. Markets should reflect the most likely future path, not the most optimistic, and that is where we are headed.”

At the same time, the market might be assuming that the latest surge in Covid-19 cases will have a larger economic impact than it actually will, explains Leuthold Group’s Jim Paulsen. The reason: The number of deaths per case isn’t rising, but remains around 1% to 2%. “Today’s case surge is concerning, but if the lethality rate remains subdued…the pace of economic growth in Q4 (and beyond) may prove much stronger and persistent…than many now believe possible,” Paulsen writes.

Other indicators also suggest that the market may be overreacting. MKM Partners’ Michael Darda notes that Treasury inflation-protected securities, or TIPS, are pricing in less inflation than they were just a little while ago, but not enough to explain the stock market’s decline. The difference between 30- and five-year Treasuries has narrowed just over four basis points during the selloff, a relatively small amount. He also points to a strong consumer confidence reading for October as another sign that the market may be able to bounce back.

“Selling into weakness is likely the wrong thing to do here,” writes Darda. “A disciplined and forward-looking approach would likely focus on using setbacks and selloffs to add to longs rather than to accumulate zero-to-negative yielding cash based on bad news that has already hit the market.”

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