How low will the Dow go? Brace yourself for the worst-case scenario

Posted by jbrumley on February 13, 2018 11:17 AM
roller-coaster

- The good news: Hitting the 200-week average is highly unlikely. Now for the bad news -

By Quentin Fottrell, MarketWatch

It seems like only yesterday that millennials were sharing their 401(k) accounts online, telling the world they were millionaires on paper. Well, it was. Or last week, to be exact.

And what a week it was.

Some said the stock market was long overdue a reality check, or two. Others believed the bull market could go on and on, and then some. After a week of nerve-wracking volatility, the Dow Jones Industrial Average fell more than 1,000 points Thursday, or 4.15%, extending its recent selloff to more than 10%. That means the Dow is now officially in correction territory.

A correction, in theory, could extend to 19%. Beyond 20% and we're officially in a bear market. That's around the time when millennials start wondering what it means for them and, perhaps worse, their parents and grandparents. Stock market corrections and downturns are typically of more interest to people who are retired - and those drawing on their savings for income have cause to worry.

Jim Rogers, the chairman of Rogers Holdings Inc. who founded the Quantum Fund in 1973 with George Soros, was perhaps the most dramatic. "We are going to have a bear market again, it will be the worst in our lifetime," he told Bloomberg News. "Debt is everywhere, and it's much, much higher now," he said. In theory, that would be more than the 54% drop in 2007 to 2009.

Rogers, who has been talking about a possible market dip for several years, added, "I'm very bad in market timing." In recent days, investors are worried about inflation and rising bond yields. But there is no subprime mortgage bubble in 2018. Still, people are rattled. On Twitter they wonder, "How low can the market go?" and, "What's the worst-case scenario?"

They are good questions, if not altogether simple ones. Here are a few things to bear in mind:

The Dow could fall another 5% from here

"Correction territory doesn't mean we'll see an immediate rebound," said Greg McBride, chief financial analyst at Bankrate.com. "A total decline of 15% wouldn't be out of the ordinary and would send a very clear buy signal." Currently, more than 10% of S&P 500 stocks are in a bear market, but McBride said he'd be surprised to see the S&P 500 fall more than 20%.

"Within the last two decades, we've had two really big pullbacks that frames everyone's consciousness around the market," added Jared Snider, senior wealth adviser at Exencial Wealth Advisors in Oklahoma City. But this correction, he said, is different. "There's no need to hit the panic button. Panic usually results in unforced errors."

A 20% total correction seems unlikely

Bottom line: There's no indication of economic troubles driving volatility, said Tim Courtney, chief investment officer of Exencial Wealth Advisors in Oklahoma City. "Our guess is that it's not going to reach that 20%. We see a 15% to 18% valuation pullback in a worst-case scenario. It's a valuation correction. It's happening quickly with a lot of force. This is normal and healthy for markets."

The extent of the drop depends on whether people focus on fear or fundamentals, said Kyle Woodley, senior investing editor at Kiplinger.com. "It could keep going on sheer fear, but then the smart money comes in and buys value. There's a fundamentally strong economy and employment is good. This 1,000-point drop comes in the middle of a really impressive earnings season."

Hitting the 200-week average is a long way off

At what point do people ask if this correction was needed or, given the sound fundamentals, overdone? "The worst-case scenario is that it breaks below the 200-week moving average," Woodley said. "The last time it broke that was mid-2008," he said, "but that was a bear market driven by a financial collapse. It stayed there until it broke back in 2010, tested it in 2011 and again in 2016."

This a complicated way of measuring market confidence. Like stock prices, they change every day. "So it's a moving target," Woodley said. The level of resistance is currently at the 18,899 point. "That's the line in the sand as of today." However, the real resistance is the line itself. So it might - as its name suggests - move higher or lower by the time the stock price approaches that line.

A market correction scares off speculators

Now for the good news. Corrections produced an average decline of 13.3% over 71.6 trading days, according to an analysis of the Dow between 1945 and 2013 by John Prestbo, a retired editor and executive director of Dow Jones Indexes, now part of S&P Dow Jones Indices. Since 2000, a correction happens on average once a year has had a decline of approximately 14%.

The sharp decline of the last week allows investors to recalibrate after a heady few months. "People have been chasing the market because interest rates have been so low," McBride said. "Stocks have been the only place to go for any sort of yield or return. A correction shakes out the speculators and the real investors come in and buy, establishing the floor and setting the stage for the next advance."

Historically, recent market crashes are very small

Context is everything. The Dow plummeted 90% in the Great Depression versus that 54% in the Great Recession. In the 1930s, the "gold standard" meant the government could not stimulate the economy by increasing the amount of money in circulation without increasing the gold reserves. Given that it took the Dow six years to recover the last time, this correction pales in comparison.

"Historically, the market has trended upward," according to Prestbo. "Occasionally, such as during the 1950s and 1990s, the gains are strong and persistent. More often the market meanders, taking one step down for every two it moves up." But buckle up for a bumpy ride, if you are a new investor in 2018. "Pullbacks of less than 5% were so common," he said, "I gave up counting them."

From MarketWatch

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