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October 19, 2018

7 Things To Know About the Market Plunge


The market shook many long-term investors to the core last week. Global stock markets plunged, causing many to doubt their strategy.

I decided to take a closer look and determine why the selling happened. I discovered that it wasn't a single factor that resulted in the plunge, but rather a combination of factors.

This article lists seven factors (in order of importance) that caused the market chaos. I firmly believe each of these bearish forces contributed to the market plunge. Some are traditional fundamental reasons, while others are related to today's market structure. Together, there can be only one result: a market sell-off. Here are 7 reasons for the plunge:

1. Blame The Machines

I know it's an oft-used excuse for bad investment decisions, but this time the algorithmic trading machines are likely to blame for the stock market's sharp plunge. In fact, I firmly believe this was the No. 1 reason for the fast selling.

It appears a waterfall of automatic stop-loss orders was triggered by the machines. The stop losses were likely placed by monstrous trend-following funds, and, once fired, resulted in a domino effect across asset classes.

The machines then, as programmed, started buying at the 200-day simple moving average (SMA) in the Dow, resulting in the severe bounce higher.

2. Donald Trump's Wackiness

While many of Trump's policies act as bullish gasoline on the stock market's fiery upward surge, his wacky, chaotic style can take its toll.

Most recently, he went nuts on the Federal Reserve, resulting in market fear that fueled the selling.

Trump calling the Fed "crazy," "loco," and "out of control" caused investors to worry he would make moves against the stabilizing force of the central bank.

Trump went on to say on Tuesday during an interview with FOX Business' Trish Regan, "My biggest threat is the Fed...because it is raising rates too fast, and it's too independent."

That is absolutely insane dialogue against the economic experts at the Fed. The Fed and the Whitehouse need to be on the same page to move the economy forward. The market hates uncertainty more than anything else by a landslide. Trump's positive impact is being hampered by the constant uncertainty he has become known for.

3. It's Overdue And Natural

Sell off's are a natural part of the market. After a huge run higher, the plunge was long overdue. Far from signaling the onset of a bear market, the 1300 point decline in the Dow Jones Industrial Average was just a 4% or so drop in the market barometer. Remember, it takes a 20% drop from the highs to signal bear market territory. All financial markets move higher in a series of ebbs and flows. The more significant the rise, the sharper the decline.

4. Profit Taking

Profit taking is the natural way the market sells off. After the massive bull market, profit taking is to be expected. Jason Trennert, who heads Strategas Research, told Barron's, "The proximate cause for the market's dip reflected mainly a desire to book profits in the big winners, notably the FAANG stocks. However, there was some "solace" in the absence of pressure from the corporate credit markets. We all learned the hard way in 2007" about the dangers posed by widening credit spreads, which warned of the financial crisis that lay ahead.

5. The Tech Sector

Tech has led the market higher in 2018, and tech has also directed the market plunge. The tech-heavy Nasdaq fell over 4% during the rout. Large tech stocks took the brunt of the selling as investors scrambled not to take profits.

6. Global Growth Forecast

The International Monetary Fund lowered its global growth forecast for 2018-2019 to 3.7% from 3.9%, which isn't a drastic shift, but when combined with the other factors, it only adds to the bearishness.

7. Advancing Borrowing Costs

Credit drives the global economy. As interest rates continue to move higher, fear of slowing economic growth starts to pressure the stock market lower. These seven factors are listed in order of greatest impact on the market. However, it takes a combination to result in a sharp plunge.

Risks To Consider: If the 200-day moving average in the Dow does not act as support, expect a significant plunge to occur. I consider three days of trading below the 200-day SMA to be a signal of more downside to come.

The "buy the dip" strategy continues to prove its worth. As long as the market stays above its 200-day SMA, buy every sell-off. I remain bullish on the stock market for now.

Courtesy of David Goodboy,  Street Authority (More from Street Authority here

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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