Volatility was the word on Wall Street last week, although the word of the week was almost “correction”.
A week of sell-offs hit its apex on Wednesday, as the Dow sank 460 points before partially rebounding to end the day only 173 points down. A 207-point rally on Friday brought the Dow back to a 155-point loss for the week. The NASDAQ briefly dipped into 10% correction territory and the S&P 500 and the Dow are not far off.
Is this an arguable correction, or a stop on the way to a bear market?
In historical perspective, the current volatility is not as bad as currently portrayed. Triple-digit gains and losses within the same week always get headlines and increase investor tension, but they have less meaning with a Dow at 16,000 compared to the past. The 507-point drop of Black Monday in 1987 was a 22% drop back then; it would be closer to 3% these days.
The CBOE volatility index (VIX) briefly jumped above 30 but ended the week at 21.99, a bit higher than the long-term average of 19.72. This relative level of volatility is not abnormal, but it seems so because of the previous period of unusual calm.
As to the selloff, there was certainly enough disappointing news to send the market down. Weakness in the European economies including the usually strong Germany, an unexpected dip in retail sales, mixed earnings reports, and free-falling oil prices were likely all contributing to the selling mood – and then, we tack on Ebola.
It seems that the general gloom of recent events and disappointing reports supplied the fuel and the Ebola news provided the spark. The sharpest drops of the week seemed to match up with the revelations of a second American Ebola case, and later, that the person had traveled on commercial flights near her contagious period.
Ebola may be causing irrational market fears because the potential economic effects are unknown. Economists have theories and methods to predict reactions to most potential shocks, but there is no template for what an Ebola outbreak could mean.
The SARS outbreak is the closest template, which caused short-term damage to the Hong Kong/Chinese economy but no major lasting damage. However, the mortality rate of SARS was 17% compared to the 70% of Ebola. Thus, the fears are magnified even though Ebola is much harder to contract.
As of this writing, two people were infected within the U.S., and those are nurses caring for the person who died from Ebola in the Texas hospital. Unfortunately, it appears that due to incomplete training or simple mistakes they experienced significant contact, and did so with an extremely contagious individual.
It is possible that there will be a few more cases of Ebola that create small panics du jour, but a true outbreak in the U.S. is not likely. Unfortunately, the early responses from the health care systems and government agencies have decreased confidence instead of increasing it, and that irrational fear has spread to the market. If more cases spread to the US and/or Western Europe, travel stocks such as airlines and hotels could suffer in the short run. But for now, it seems unlikely Ebola will have a big impact on the broader economy or investment outlook.
So far, this seems to be an expected partial correction, a dip similar to February of this year, and not the beginning of a bear market. There is still scattered good news, such as a continuing drop of the jobless rate and a rise in the industrial output. Corporate earnings so far have been mixed, but not bad enough to suggest rough times ahead. Forward P/E ratios for the Dow and S&P 500 are in the 14-15 range, and there is still no hint of a rise in interest rates.
In reality, nothing approaching a longer correction — or full-fledged bear market — is likely to hit until the Fed raises interest rates. While America’s economy perked up in the second quarter with a 4.6% growth rate (as the economy caught up from a weather-induced contraction last winter), concerns about stagnant European economies and the turbulent world situation will probably keep the Fed from acting sooner than their widely anticipated movement next year, and it may even revive bond-buying stimulus or similar efforts.
The relative low points may represent opportunities to pick up stocks at bargain prices. Pure market timing is difficult, especially with this level of volatility, but if a stock fits in with your diversification plan and is available at a lower price, it seems reasonable to take advantage.
However, all it takes is any confirmation of a casual, less direct contact causing an Ebola infection, such as an untreated tourist causing a transfer outside the medical system, and all bets are off. It is almost certain that there will be a significant market dip in that case; it is not certain that reason will prevail as it did this time.