Yesterday's Selloff Was Dumb, But It Might Not Be Over; What Investors Should Do Now

I know it sounds kind of geeky, but let’s get it out there: I love markets, and not just because I have made a living in and around them for most of my life. There is an elegance -- a beauty even -- to the way the collective wisdom of thousands of people and institutions, each considering hundreds of data points and influences, is distilled into just one number: the price of an asset.

However, having said all of that, as any parent of a teenager knows, it is possible to feel love and yet recognize that, sometimes, a person or thing can act really dumb. That is how I feel about the stock market over the last few days.

I don’t want to get too carried away, as so many in financial media have done, but we have witnessed a bit of a selloff in stocks. The S&P 500 dropped around 3.5% from Monday’s close to yesterday’s, with the Nasdaq leading the way down, off around 6%. That doesn’t sound like much, but if you go back to the highs three weeks ago, the Nasdaq has fallen 10% and the S&P nearly 5%. Again, all within normal bounds for a consolidation, but there is some worry.

The selling accelerated yesterday afternoon as Fed Chair Jay Powell delivered a speech at a Wall Street Journal conference. In more ordinary times, he made what would have been seen as pretty innocuous remarks, saying things he has said before, such as that there is some evidence of inflationary pressure, but not enough to warrant any change in policy. For this market right now, that unremarkable stance was enough to produce this reaction:

I guess traders had been looking for Powell to express worry about a move up in Treasury yields and announce yet more QE in response. However, for the Fed Chair to do that when yields have “jumped” to around half where they were a couple of years ago, a level way below their long-term averages, would have been stupid and irresponsible. Still, when they didn’t get what they wanted, traders, just like teenagers, threw a tantrum.

Let’s put this in context. The U.S. economy is recovering from a massive shock. That recovery has been a gradual process, but is beginning to accelerate as the vaccination program picks up and Covid cases have started to fall. There is still elevated unemployment, but people are gradually getting back to work. All that good news comes even as Congress is mulling a big stimulus package, and the policies that Powell talked of continuing are pumping huge amounts of money into the system. Those aren’t conditions that warrant a selloff, unless, of course, the selloff was coming anyway, and Powell’s speech was merely the excuse.

That looks like the most likely explanation here. The market had pushed valuations beyond their logical levels and was looking for someone other than themselves to blame for that.

That doesn’t mean, however, that the selling is over. If there was an underlying lack of confidence in stocks at the highs, that won’t have gone away because of a correction of a few percentage points. What it does mean is that for individual investors, joining in the selling, especially at this point, would be a mistake. We may well see some more short-term volatility, but we will be looking at new highs again before long.

Even if you do sell, what are you going to do? Are you going to sit on cash which, in an inflationary environment, is losing value? Or are you going to buy bonds that are falling in price to get a 1.5% annual return? Maybe you want to put your life’s savings in Bitcoin? Or buy some oil and store it in your back yard?

You get the idea.

Stocks had to correct back at some point, and a hissy fit over what Powell didn’t say is as good an excuse to start that process as any. This excuse may be dumb when looked at logically, but the underlying understanding that the market had got ahead of reality makes some more selling possible. Still, stocks are the best place to be right now, and as long as fiscal and monetary stimulus continue to swell the pool of cash looking for a home, the chances of a major crash look slim.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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