Consider Last Week's Market Move a Warning

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Last week the Dow Jones Industrial Average (DJINDICES: ^DJI  ) fell 232 points, or 1.48%, and now sits at 15.425. During the week we saw a few different economic data reports, but not an overwhelming amount and certainly nothing overly important like GDP or a jobs report. But something happened on Tuesday that was key in moving the markets lower for the week.

On Tuesday, not one but two Federal Reserve officials told the media that they believed the central bank will soon start tapering its $85 billion bond-buying program. The Atlanta and Chicago Fed presidents both think the latest round of quantitative easing will slow from its $85 billion mark to a smaller amount sometime during 2013, and that the matter will be voted on during one of the three remaining Fed meetings this year.

The S&P 500 and the Nasdaq also declined this week, by 1.06% and 0.79%, respectively over the past five trading days. So if the markets drop by roughly 1% just on the news that the tapering might soon start, what's going to happen when it actually does start?

Back in May, my colleague Dan Caplinger discussed the idea that the stock market was overdue for a correction, and since then we haven't seen even the 5% move lower that we typically observe about three times a year. In fact, we haven't seen a 5% correction since last November. We're way overdue, and I think we'll easily get that 5% drop when the Fed does announce that the tapering will begin.

But that doesn't mean you should sell your stocks and wait for the move to happen. While a 5% correction typically happens three times a year, we see a 10% correction about once a year, and a 20% correction once every three and a half years. If we were to trade based on what's typical for the correction cycle, we would have sold stocks back in April to avoid a 5% correction, and with the last 10% correction happening in August of 2011, we would have been out of the market for almost a year.

Looking back to just the beginning of April, the Dow is up 846 points, or 5.81%. If you were truly worried about the 5% correction and sold in April, you not only didn't get the correction you were looking for, but you also missed out on all those gains. Similarly, if you sold at the start of August 2012 because you wanted to miss the predicted 10% decline, you not only didn't get a 10% move lower, but you would have missed out on an 18.59% jump in the Dow.

Worrying about a correction and when it may come based on historical trends, what's happening in the news, or even what the Fed officials are saying will probably cost you much more money than it will save you. But if you're still concerned about a possible correction, read more about what you should do if you knew a correction was coming.

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  • Report this Comment On August 12, 2013, at 3:10 AM, John10111966 wrote:

    You stated there hasn't been a 5 % pullback since the May article. Well that's not true. There was a rather sharp quick pullback down to SP 1560 in June after reaching about 1670 in May. Each move down by 16.7 SP points is 1%. Since the total move down was about 110 points this puts the percentage move down 16.7 multiplied by 6 is 100.2 so that tells me the move was roughly slightly over 6.5%. How can you write an article and expect to be taken seriously when the facts are not stated correctly. I am a technical analyst so when I read this I was simply amazed misleading it is.

  • Report this Comment On August 12, 2013, at 11:58 AM, RMengineer wrote:

    "So if the markets drop by roughly 1% just on the news that the tapering might soon start, what's going to happen when it actually does start?"

    And let's not forget that's just talking about slowing the digging of the hole. That's not even stopping digging. AND that's not even talking about _unwinding/undoing_ all that QE. If they can't even _talk_ about _only slowing_ without causing adverse economic results, how are they ever going to _undo_ QE like they _promised_ as an argument for doing it in the first place?

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