Making Sense of Last Week’s Market Drop

Has the valuation bubble finally burst?

Last week was the 40th worst week in the market since 1950, so it was a big deal. How bad was it? Worse than 99% of all weeks in the last 70 years. Here are the numbers.

3696 total weeks since 1950

2100 up weeks
1592 down weeks
4 flat weeks

Up weeks:
Median 1.17%
Average 1.49%

Down weeks:
Median-1.19%
Average-1.58%

Last week:

Down 5.64%

Which sectors are bearing the brunt and which are holding up well?

Next we drill down into the 11 sectors that make up the S&P 500 and look for clues about where money is leaving and where it's going. In a broad sense, value stocks are beginning to close the gap with growth stocks, and defensive stocks are catching up to cyclical stocks.

The next three charts show the sector rotation that's going on in the market. I have focused on three time frames - 5 days, 1 month, and year-to-date performance for the eleven market sectors. 

Utilities, a defensive sector, held up the best last week. Consumer Cyclicals bore the brunt, along with Industrials and Tech. We can begin to see a pattern already. The previous high-fliers in terms of sectors gave back ground to more defensive and yield-oriented ones.

Utilities held up the best over the last week and month. Tech bore the brunt. The pattern continues.

Sector performance year-to-date.

The picture changes dramatically when we widen the lens to this setting. Despite their recent give-backs, Consumer Cyclical and Tech still lead the market. The only constant in these three time frames is the struggling Energy sector. 

When will the long suffering Energy sector begin to move up the performance tables? I don't know, but I have been nibbling on VDE for a few months now. 

The October give-back is all about the Covid spike and U.S. election drama.

The recent surge in cases and deaths are the real story, but this article focuses on how the surge might impact the economy and the market. The U.S. might be headed in the direction of more restrictions, mask mandates, and lockdowns. 

That does not bode well for the nascent economic recovery we saw this summer. Unemployment may begin to rise again, small businesses may continue to fail, and a potentially contested election will add further uncertainty to the picture.

Where we are YTD on the S&P 500

The chart below shows where we are in the S&P 500 as of today. On the left we see periodic returns for various time frames. On the right we see the distance from key markers. 

After the last week, the market is only up by 1.2% YTD. And its up by 7.4% year-over-year after being up 38% before the pandemic struck.

This qualifies as a weak year, but don't count the dip-buyers out yet. They could rally the market higher before year end.

Will the dip-buyers return to save the day?

The chart below shows that the dip-buyers have only allowed three declines of 5% or greater since the recent bottom in March 2020. Will they show up once again in November? 

Don't underestimate the dip-buyers. Mostly retail types, they have been in control of this market since March 23rd. They have the Powell Fed on their side. And there seems to be no limit to the amount of risk they are willing to take, including options and leverage. 

As Benjamin Graham said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” Since the recent bottom on March 23rd, investors have been voting for a speedy recovery and a return to normal. Today's action marks the beginning of the weighing machine market.