Investors’ reaction this week to Ben Bernanke’s comments about the future of the Federal Reserve’s stimulus programs were nothing less than insane. Well, perhaps “insane” isn’t quite right. The market has looked more like a toddler throwing a tantrum when a grown-up told him he can’t have his way all the time.
The Dow Jones Industrial Average lost 1.79%, or 270 points, this past week. On both Monday and Tuesday of last week, the Dow rose by more than 100 points each day. But on Wednesday and Thursday combined, the blue-chip index fell more than 550 points, after the Fed chairman told investors that the central bank sees signs of a strengthening economy, and as that long as the economy continues down its current path, the central bank will soon begin slowing its stimulus programs. Cue the tantrum. The markets experienced their worst week in nearly two months.
Even though the Dow rose by more than 200 points during the beginning of the week, the past five trading sessions added up to the worst week since April 15-19, when the Dow lost 317 points, or 2.1%. But one big difference between this week and that one is that in April, the Dow had only 19 losers at the end of the week. This past week, 27 of the Dow’s 30 components saw their prices decline.
Furthermore, back in April, the Dow’s worst performer was International Business Machines Corp. (NYSE:IBM) which lost 10.11%. The reason that matters is that the Dow is a price-weighted index, which means that stocks with higher prices have a larger impact on the index. Since IBM represents 10% of the Dow’s total score, when it lost 10% in April, it singlehandedly cut around 160 points from the index, or around half of its loss that week.
This past week, in contrast, International Business Machines Corp. (NYSE:IBM) lost 3.74%. That’s still a large decline, but it represents only about 57 points of the Dow’s 270-point loss. This time around, AT&T Inc. (NYSE:T) was the index’s largest decliner, losing 4.47% this past week, but the stock represents only about 1.4% of the Dow, so it didn’t play a major role in tanking the index. The next largest decliner, at 4.13%, was Travelers Companies Inc (NYSE:TRV) — which, besides AT&T, was the only other component to lose more than 4% of its value. But, while Travelers’ weight is substantially larger than AT&T, it still makes up only 4.1% of the index, ranking it as the 10th heaviest component.
The point is that this past week’s drop was a broad market descent, meaning that stocks in general across the board declined in value, based on news at a macro level. As the old Warren Buffett saying goes, “Be fearful when others are greedy, and greedy when other are fearful.” This is one of those times we should be getting greedy.
The insanity took control when investors were told by the Federal Reserve’s Chairman that the U.S. economy is growing stronger. That should signal to investors that corporate revenues and profits should be rising in the future. If we believe that the long term price of a stock is based on profits, then we should be buying stocks today with the belief that higher profits will be had in the future. Additionally, when we see big market moves due to macro events and not company specific news, this should make a value investors mouth start to water. The market is essentially selling shares of quality companies at a discount for no logical reason.
Now one theory for the reason stocks fell when Bernanke spoke last week was that investors believe when the Fed takes its foot off the gas, the economic growth we have seen over the past few years will come to a halt and we will experience a period of extremely low GDP growth and corporate profits will struggle. The problem with this theory is that the Fed has told investors that if economic growth begins slowing after it slows down stimulus; it will come back in and give it another kick start. This tells me that the Fed will essentially back stop the stock market at a level it fells is appropriate.
So based on what we saw last week, if the markets fall even when the Fed just talks about slowing its stimulus and if the theory about a slow economy in the future is true, we will likely see a few more big drops from the market in the coming months. If the markets continue to fluctuate it should give long term value investors some great buying opportunities in the future. Furthermore, if we practice the principle of buying in thirds, we should be able to fully build a position in the coming 6 to 12 months during days or weeks when the market is falling due to macro events like we experienced this past week.
The article The Insanity of the Market’s Reaction to the Fed This Past Week originally appeared on Fool.com.
Fool contributor Matt Thalman has no position in any stocks mentioned. Check back Monday thru Friday as Matt explains what caused the Dow’s winners and losers of the day, and every Saturday for a weekly recap. Follow Matt on Twitter @mthalman5513. The Motley Fool owns shares of International Business Machines (NYSE:IBM).
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