It may not have been the most important day, but it was significant to me, nonetheless.

During the first hour of trading, with no obvious trigger, the major stock indices dropped by about 5%. For the fading techy stars of 2020-21, the negative numbers were more like -10%. Just as suddenly, the market reversed itself. Positive momentum was the greatest for the first-hour’s biggest losers, which by and large finished up on the day.

Why is this movement potentially important?

In every down market (we’ve been in one for what one might call Cathie Wood stocks for about a year), investors of all stripes tend to hold onto their former winners despite mounting losses. At some point, the red ink becomes too difficult psychologically for even professional investors to bear. Even though holders’ brains may be telling them it’s the wrong thing to do, they give in to their fears–and to their customers’ calls for change–and dump out their underperforming stocks without regard to price.

This angst-driven selling capitulation invariably marks the bottom of the market. It frees capital to be redeployed away from losing stocks. More important, it serves as a market signal that the worst of the decline is over.

The worst of these that I can recall came in 1987. To put the story in much too simple terms, during that summer, 30-year Treasury yields (the benchmark back then) rose to 10%. The PE on the stock market at that time was 20x, indicating a severe overvaluation of equities relative to fixed income. (There were also federal deficit and currency problems, but I’m ignoring them. The link in the next sentence has a fuller account.) On what came to be known as Black Monday October 19th, much of this imbalance was rectified through a one-day drop of 20%+ in stocks. Stocks also closed at the lows, another apparently bad sign.

Although things looked pretty grim overnight (one of my portfolio colleagues had a nervous collapse on the subway on the way home, had to be hospitalized and never managed money again), the Monday lows held.

I have no idea why, other than that it happens, the market always seems to bounce and then come back to “test” the lows several weeks later. If the market reversed course at or slightly below the prior lows, this is taken as evidence that forced selling is over and the previous downtrend is no longer something to worry about.

Three aspects of today’s situation:

–yesterday’s decline, while a little scary, was relatively modest. My guess is that we continue to trade with yesterday’s worst levels in the market’s mind until we get more evidence that this is indeed a low

–bond and stock valuations are nowhere near as out of whack as they were in 1987

–if we look at overall market action over the past year, there’s little sign of trouble. Yes, stocks have been declining since last November, but the overall drop has been modest. True, but look at the stay-at-home stocks or the Cathie Wood universe. There the story is very different. At yesterday’s lows, ARKK, Wood’s flagship fund, had dropped by 58% from it’s February 2021 high. This is a whale of a bear market, and it’s been going on for almost a year. HOOD has gone from a high of $55 to $11, for example, ZM from $479 to $149, PTON from $150 to $24.

more tomorrow