Blue Haven

Sell-Offs Have A Template And This Ain’t It

By December 5, 2019 No Comments

The stock market is on track to end the year up more than 20% and we think it will avoid a dramatic drop into the end of the year. December started out with a two-day drop of 2% which quickly reminded investors of last year’s December collapse. However, the market appears to be in a much better spot heading into the final weeks of the year compared to last year. We can’t predict what the stock market will do, all we can do is interpret how it is acting. So with that said, we see a stock market that has remained resilient even as the US and China have yet to reach an official trade deal.

Markets aren’t weak

The main difference between this year and last year is that markets were showing concern at this time last year. From the beginning of September 2018 to the beginning of December 2018, the S&P 500 had fallen 5%, including a volatile drop of 8.50% in the middle of October 2018. Put simply, markets were weaker and significantly more volatile heading into December 2018. That is not the case this year. The S&P500 is up close to 8% over the same period and was not volatile for most of October and all of November:

Markets tend to give warning signs that something is wrong much in the way you might show symptoms when you’re getting sick. The biggest warning sign is when prices drop and fail to recover. This is similar to you being sick for three weeks and none of your symptoms are going away. Notice last year that after the S&P 500 fell 5%, it struggled to recover those losses.

The failure to recover price declines leaves markets vulnerable to an acceleration in selling, which is exactly what we saw in December of last year:

Sell-offs have a template

While it’s impossible to know when a sell-off is about to erupt, history suggests that smaller sell-offs precede larger ones. We’ve shown how that was the case in December 2018, but there are other instances as well. For example, Black Monday, when stocks fell 20% in a day in 1987, occurred after they had already fallen more than 10% from their peak that year.

The 2008 financial crisis may contain the year 2008 in the headlines, but it was 2007 when the stock market actually peaked. By the end of 2007, the S&P 500 had fallen more than 5% from it’s high and was failing to recover. Before Lehman Brothers collapsed in September 2008, the S&P 500 had already been down 20% for more than two months.

So what about now?

While it is true that stocks did decline 2% to start the month, context matters. The 2% drop would have been much more concerning if it had followed a 5% decline in November. But in fact, stocks rallied 4% in the month of November and are up more than 20% this year. Stocks have historically weakened before significant price declines. And so far, we’re not seeing enough sustained weakness to change our near-term outlook.

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