After an ugly day like we had yesterday, we should expect the market to stabilize a bit. It's very rare for the market to drop by more than 1.5% three days in a row.
After the worst day so far this year on Thursday, when we sold off on large volume and declining stocks far outpaced advancing stocks, it is reasonable to look for some sort of bounce. It's just the nature of the market. However, the action over the past two days is a bad sign and indicative that something has changed in the market.
Market participants have enjoyed small pullbacks over the past few years with little fear of a steep decline because they could always count on a friendly Fed and its unending supply of liquidity. However, we may not be able to count on the Fed (at least that is the perception) to keep on buying bonds and this adds real risk to the idea of a quick recovery in the markets. The liquidity has been the main driver of the markets over the past few years.
.
As we mentioned last week, it was odd to see so many sectors and asset classes declining without pause. We stated that it was either a correctional rotation out of certain sectors and asset classes into other sectors/asset classes, or it is foreshadowing a change in market behavior. We now know it was foreshadowing a possible change in market behavior.
While it's impossible to predict what the market will do over the next week or month, we can always hedge against various outcomes. One way to do this is to raise some cash to protect against downside risk. Cash also allows one to take advantage of opportunities created by the increased volatility.
It's possible this could be just your run-of-the-mill correction in the global markets; with the markets eventually finding a floor and recovering to new highs. It's also possible that global markets, driven mainly by central bank liquidity, are realizing that maybe they can't make it on their own.
