Does Something Wicked This Way Comes?

A dramatic shift in the market occurred this week. The tremors started Wednesday, when Tech stalwarts Tesla and Apple saw their stocks decline while the market indices continued to march higher. The subtle tremor may have gone unnoticed by the many, who could have simply perceived the drop as a rally pause after both stocks witnessed meteoric rises on the backs of what was nothing more than a stock split announcement. After all, what is a 7% decline matter after a 600% rise since March in the case of TSLA (Apple’s 144% from the March lows to Wednesday’s high looks like a Muni-bond return in comparison). But the two stocks’ impact on the overall market goes beyond the cap-weighted influence they have on the Nasdaq 100, the stocks themselves have been an important barometric reading of the rising risk appetite for investors.

What began as a small tremor on Wednesday turned into a full-blown earthquake Thursday morning. The Nasdaq fell 2% on the open yesterday and before the second hour of trading was completed it had fallen over 5%. When it was all over the Nasdaq had fallen roughly 6% and the blue-chip S&P 500 shed 4%. Markets have continued to fall this morning, with the tech-laden Nasdaq losing another 3.5% at current time of writing. The massive momentum unwind has been sharp, sudden and brutal, but the bigger question that remains is whether this is the beginning of a larger shift in market direction or simply a large(ish) correction.

Certainly, the stock market has seen a dramatic recovery from the pandemic-fear lows of March. The S&P 500 had risen over 60% from the bottom. This rise has baffled many people who follow the macro-fundamentals of the overall market and economy. The impact of the virus-shutdowns have had a tremendous strain on many parts of the overall economy, but many investors have been betting heavily on the technological shifts driven my remote working and living under social-distancing measures. Some businesses have seemingly sprung out of nowhere like Zoom, while others like AMC Theaters have been crushed by absence of in-person business. Making sense of all these changes have led to many, myself included, to struggle to comprehend the market’s rise. Decision making in times of dramatic changes is nearly impossible, or maybe only further hammers home the reality that decision making in complex environments, like financial markets, is always difficult.

We are flawed creatures when it comes to making decisions. Sometimes our emotions cloud our rational thinking, and sometimes even rational thinking is impossible because we cannot proficiently evaluate all the variables. If we are trying to determine if this sell-off is the beginning of a bigger downward trend or just a bump on the road to higher future levels, relying on intuition can prove futile. Currently, I could come up with arguments to support both cases, but in moments of clarity I can see them for what they really are—guesses, at best. Sticking to a model is the only way that I can prevent myself from allowing my guesses to become bigger errors. Models for investing are crucial in keeping me from being my own worst enemy. Models are imperfect, clearly, but models are less prone to realizing worse case scenarios. Models can help us follow trends in asset selection, but they can also help us in making financial planning decisions. Models can be complex algorithms for crunching data of market prices, or as simple as setting up a 401(k) plan that includes systematic contributions with annual increases. Models can also help us determine withdrawals schedules for financing your retirement. Models can help us see the larger picture rather than the more confusing pixels.

These daily and weekly market gyrations are the pixels and we need to view them as such. It is easy to forecast out the current state into the future, but that can prove disastrous if, and when the current state is at extremes. One thing I can say is certain is that the last 6 months have been an extreme. We cannot nor should not make too much of the rally that has taken place nor attempt to draw too many conclusions from the sell-off this week.

Thanks for reading,

Zach and Dave  

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