What’s Behind the Market Decline

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By Steve Wolff

Now for the understatement of the day…volatility has returned to the stock market.

Why has the stock market gone down with such force in the last week? I think there are a few reasons.

  1. Profit taking. Stocks had run up extremely quickly over the last year or so, especially in January when the indices were up by around 8%. So it is normal for profit taking to occur.
  1. Rising interest rates. Some investors have been spooked by the rise in interest rates. The 10-year government bond has risen to around 2.9%. They also believe the Federal Reserve is going to raise rates 3 or 4 times this year. When interest rate on bonds get high enough, they are competition for money that is now in the stock market. So the people who worry about this decided to sell some of their stocks.
  1. Forced Selling. Perhaps the main reason for the stock market dive has been caused by hedge funds and others who invested in something called the VelocityShares Daily Inverse VIX Short Term Exchange Traded Note (and other securities like it). It is a security that bets on the volatility of the stock market. This is a highly leveraged security that is great when there is no volatility in the market.

Unfortunately, the spike in volatility in the market has caused some of these Exchange Traded Notes (ETNs) to nosedive by as much as 80%.  Because they are leveraged, the hedge funds and other investors were losing a fortune and had to cover their margin calls. How do they raise money to cover the margin? They sell stocks that they own. This is what’s known as forced selling and it is happening in spades.

Are We in A Bear Market?

Does this indicate the start of a bear market? I don’t think so because the earnings that companies just reported were pretty good. Nothing has changed with the economy in the last week, just the price of stocks.

We might be in for a few more days of this until the forced selling abates. I do not believe this is the time to do any wholesale selling because the economy is still good. The tax cuts haven’t even started to kick in yet.

The advice from us is to sit tight, stay calm and if you have the cash be ready to gobble up some good stocks that continue to be forced lower.

As always, we are here for you, so if you have any questions, do not be afraid to contact us.

You can reach us at 760-692-5190 or Steve@WWMFinancial.com