Thursday's gap lower on high breadth has only happened twice before. Both times, the Nasdaq dropped at least 30%.
Sure, history may not exactly repeat itself, but it does rhyme. So when there are big drops in the stock market like Thursday’s, a bit of perspective can be helpful.
Typically, a big down day is followed by a counter-rally the next day that partially covers the losses–and so far, that setup looks intact.
But over time, once the initial drop has occurred, sentiment can quickly shift from bullish to bearish. And Thursday’s selloff in the Nasdaq suggests at least a 30% drop. Worst case? It could slide as much as 80%.
That’s because Thursday’s selloff was over 5.3%. And the high negative ratio of advances to decliners shows that the index selloff had enormous breadth.
In today’s world, where a company like Apple (NASDAQ:AAPL) can dominate the index, a bad trading day for that company can move the market.
But when that happens, traders tend to shrug it off. And when things are going well, it’s easy to make wild predictions about a company’s prospects.
When most stocks are in agreement on a selloff, that’s a sign that traders may be moving to liquidate everything.
Thursday’s high-breadth selloff has only occurred twice before.
The first was back in March, against the initial 2020 market selloff. Then you have to go back to 1999, during the height of the tech bubble peak.
In March, stocks had their fastest pullback in history. In 2000, the Nasdaq started an 80% plunge after years of being the best investment game in town.
Back in 2000, an investor could take their money out of the high-flying tech sector and invest in bonds, getting a hefty 5% or 6% yield.
Today, with interest rates close to zero, a 1% yield is still tough to find without buying junk bonds.
That’s partly why stocks have held up so well—the alternative has such poor potential returns that stocks look like a reasonable bet. And that’s a compelling argument that market bulls will make from here.
But as in 2000, valuations matter. Back then, investors poured money into risky startups with no cash flow–and often no plans to create cash flow for years!
Today, stocks are a riskier bet than they appear–even the so-called blue chips–due to high valuation.
Capital rushing into those trades has pushed dividend yields down at a time when many companies are suspending or eliminating their payouts.
And, of course, back in 2000 at the height of the tech bubble, we had the same kind of insane retail sentiment that’s cropped up in the Nasdaq in recent weeks.
When retail traders are touting their massive returns and mocking professional money managers who have gone through multiple cycles, it’s often a sign of a top. Ditto the rise of companies with a big, attractive story, but no actual financial success behind it yet.
Because history doesn’t repeat itself exactly, we may yet escape another crash. If we do get one, it may prove smaller than the tech bubble.
But even after Thursday’s harrowing drop, caution is warranted.
Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice by CCN.com. The author holds no investment position in the above-mentioned securities.
Last modified: September 23, 2020 2:00 PM