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Why the stock market was in the red – and what to do now

The


Stock market

is finally on the decline, which investors should have expected after five months of gains. Now is the time to weather the storm.

It's certainly been a stormy week for the stock market. The


S&P 500

fell 0.7% on Tuesday, its biggest decline in nearly a month. And for once it feels like there's almost no place to hide. Three S&P 500 stocks fell on each advance, and only two sectors – energy and utilities – finished higher on the day. There is no rotation here. The


Cboe volatility index,

or VIX climbed 7% to 14.61, its highest since March 11.

Blame rising bond yields for the decline in stocks. The 10-year Treasury yield rose as high as 4.39% on Tuesday before slipping back to 4.373%, but is still at its highest level of the year. Furthermore, the recently calm volatility in the bond market has suddenly returned. The Merrill Lynch Option Volatility Estimate, or MOVE Index – the bond market's version of the VIX – rose 9% on Monday, its biggest percentage move since Jan. 2.

The stock market does not want to experience interest rate volatility. According to 22V Research, there has historically been a close connection between stock and bond market volatility. Given the current state of the movement index, the VIX could be slightly higher. This is particularly true given the fact that the


SPDR S&P 500 ETF

has delivered incredible returns with low volatility, according to Citrini Research, with “a Sharpe ratio of 4+ over the last six months,” conditions that are almost too good to be true. “I'm not bearish, but this is relatively unsustainable in my opinion and I wouldn't be surprised to see a natural pullback to recent SPX highs,” writes James Van Geelen on Citrini Research's Substack.

The question now is whether a correction – defined as a decline of 10% or more – will begin. It wouldn't be a surprise if it were. After all, according to Dow Jones market data, corrections have occurred in most years since 1980. Additionally, the S&P 500 is up about 26% since its late October low, and some technicians have warned in recent weeks that the market has come too far too fast. And with the index trading at 21 times 12-month forward earnings – a high figure relative to earnings – any disappointments as earnings season begins next week could cause share prices to fall.

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Another risk is that the Federal Reserve may not cut interest rates as often as the market currently expects, which could keep interest rates at elevated levels and ultimately slow economic growth.

The technical data is not reassuring. The S&P 500 has fallen close to its 20-day moving average of 5178, a signal that it is losing momentum and could fall further. “Be alert when stocks breach their 20-day moving averages,” writes Craig Johnson, chief market technician at Piper Sandler. “The weight of technical evidence suggests that the S&P 500 is vulnerable to a 5-10% decline/correction in the coming weeks/months.”

So what should investors do now? Nothing. It may not be a good idea to buy more, but sticking with the index is. The economy is still growing and companies can continue to increase their profits. The Fed almost certainly won't raise interest rates. The stock market may have to take a short-term dip before it can resume a long-term rise.

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“We view these pullbacks and consolidations as a healthy sign in the context of the current medium-term uptrend,” writes Johnson.

The market is not a buying or selling. It's a hold…until it becomes a buy again.

Write to Jacob Sonenshine at [email protected]

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