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Why the Dow's Big Drop Wasn't All That

| February 11, 2018
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Wall Street made history Monday afternoon when the Dow Jones Industrial Average closed down 1,175.21 points, or 4.6%. That 1,175-point drop was the Dow's largest single-day point decline since the market indicator was created in 1896. It also followed Friday's 666-point loss, which had been the sixth-largest decline in the history of the Dow.

What caused the recent downdraft? Although we can't pinpoint a single event, it could be carryover from Apple's and Alphabet's disappointing earnings results or guidance.

Or the growing fear of rapidly rising interest rates. (Early indications from the Atlanta Federal Reserve are that the U.S. economy could grow by more than 5% in the first quarter, which could ignite inflation and require the Fed to get more aggressive and raise rates.)

Or it could have been computer-driven selling.

Yet a more Foolish (and realistic) answer comes from small-cap advisor Seth Jayson, who told Hidden Gems members this week:

“The real answer to the question of 'Why are stocks dropping?' is: 'We don't know.'"

Putting the 'plunge' into perspective

However, the fact of the matter is that the Dow's drop, even at its intraday peak of nearly 1,600 points, wasn't among its biggest percentage moves of all time. In fact, it wasn't even all that impressive considering the history of the Dow.

Below is a table showing the Dow's 20 largest single-day declines, in terms of points and percentages, through Monday.

Largest Daily Point LossesLargest Daily Percentage Losses
DateCloseNet Change% ChangeDateCloseNet Change% Change
2/5/1824,345.75-1,175.21-4.60%10/19/871,738.74-508-22.61%
9/29/0810,365.45-777.68-6.98%10/28/29260.64-38.33-12.82%
10/15/088,577.91-733.08-7.87%12/18/189958.27-7.94-11.99%
9/17/018,920.70-684.81-7.13%10/29/29230.07-30.57-11.73%
12/1/088,149.09-679.95-7.70%11/6/29232.13-25.55-9.92%
10/9/088,579.19-678.91-7.33%8/12/3263.11-5.79-8.40%
2/2/1825,520.96-665.75-2.54%3/14/0776.23-6.89-8.29%
8/8/1110,809.85-634.76-5.55%10/26/871,793.93-156.83-8.04%
4/14/0010,305.78-617.77-5.66%10/15/088,577.91-733.08-7.87%
6/24/1617,400.75-610.32-3.39%7/21/3388.71-7.55-7.84%
8/24/1515,871.35-588.4-3.57%10/18/37125.73-10.57-7.75%
10/27/977,161.15-554.26-7.18%12/1/088,149.09-679.95-7.70%
8/21/1516,459.75-530.94-3.12%10/9/088,579.19-678.91-7.33%
8/10/1110,719.94-519.83-4.62%2/1/1788.52-6.91-7.24%
10/22/088,519.21-514.45-5.69%10/27/977,161.15-554.26-7.18%
8/4/1111,383.68-512.76-4.31%10/5/3266.07-5.09-7.15%
8/31/987,539.06-512.62-6.37%9/17/018,920.70-684.81-7.13%
10/7/089,447.11-508.39-5.11%9/24/31107.79-8.2-7.07%
10/19/871,738.74-508-22.61%7/20/3396.26-7.32-7.07%
9/15/0810,917.51-504.48-4.42%9/29/0810,365.45-777.68-6.98%

TABLE BY AUTHOR. DATA SOURCE: WIKIPEDIA, THE WALL STREET JOURNAL, DOW JONES.

What you'll note right away is that many of the Dow's largest point declines aren't anywhere near its largest percentage losses of all time.

More importantly, we have to take into account that the Dow has grown considerably over time. For example, Monday's point drop was more than double the point drop during the Black Monday crash in 1987 (1,175 versus 508), yet the percentage decline was only about a fifth as great (-4.6% versus -22.61%). The Dow has increased in value more than tenfold since 1987, so you need to consider those gains when thinking about aggregate point moves.

Although it's a bit out of the ordinary, Monday's 4.6% drop in the Dow is something the market has witnessed dozens of times before (though perhaps you haven't, if you started investing in the past nine years). Rest assured that we'll see similar drops many more times in the future.

What you can do right now

All the market volatility have you a bit unsettled? Here's how you can take control of your investing.

First and foremost, know that any money you need in the next few years should not be invested in the stock market. This is true regardless of what the market is doing — it's just smart financial planning.

Okay, back to the market.

Although your first instinct might be to panic when you hear about a "record decline in the Dow," the smartest actions you can take right now are the three "Rs": relax, review, and reload.

First of all, relax! Declines — and even so-called corrections (a drop of 10% or more) — are perfectly normal. According to Yardeni Research, the broad-based S&P 500 has had 35 drops of at least 10% (when rounded to the nearest whole number) since 1950. That's about one every two years. Our last correction was about two years ago, so according to the averages, we're due.

It might also calm your nerves to know that staying the course is your most prudent option. Although you might be tempted to dive in and out of the market in an effort to time its pops and plunges, it's simply not something that can be done with any accuracy over time.

For example, in 2016 J.P. Morgan Asset Management released a report entitled "Staying Invested During Volatile Markets" that analyzed the S&P 500's performance over a 20-year period between Jan. 3, 1995, and Dec. 31, 2014. What the report found was an aggregate 555% gain for investors who held throughout the entire period. If investors missed just 10 of the best percentage gains over this 20-year period, their gains were cut to just 191%. If they missed a little over 30 of the best days, their gains would have completely disappeared. And, to boot, a majority of the largest percentage gains came within two weeksof the biggest single-day losses. In other words, stop guessing and stay invested.

Second, take this time to review your holdings. If the reasons you bought your companies still hold true, then you have no need to worry or do anything rash like sell your holdings. If you're concerned that your company's fortunes might be turning, check out its balance sheet. Over-leveraged businesses tend to suffer most when the overall market sags.

Finally, consider reloading on existing positions or opening new positions if your investment thesis still holds water. If you're feeling cautious about that, consider investing in dividend stocks, which often have time-tested business models and are considered beacons of profitability. It's unlikely that a management team would authorize the ongoing sharing of profits if it didn't foresee continued growth. Plus, the dividends you receive can help somewhat hedge your downside during a correction, as well as aid in building wealth through reinvestment.

The Foolish bottom line

Although corrections are commonplace, the stock market has proven to be one of the greatest long-term creators of wealth, with an average annual gain of 7% a year, including dividend reinvestment and accounting for inflation. Not to mention that some of the stock market's best days of all time tend to occur within a few weeks of its worst days.

Remember, trying to time the market over the long run isn't possible, so staying the course is your best path to long-term riches. And the Fool is right here to help you keep investing — no matter where the market takes us.

The views depicted in this material for information purposes only, and should not be considered specific advice or recommendations for any individual.

All investing involves risk, including the possible loss of principal.  There is no assurance that any investment strategy will be successful. Indices are unmanaged and cannot be invested into directly. Past performance is not indicative of future results.

Dividends are subject to change and cannot be guaranteed.

Source:https://www.fool.com

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