Yesterday the NASDAQ “collapsed” 1.80% and this was seen by most as a sign of weakness in the markets. Now, while I will not attempt to convince you that stocks are valued fairly, I can say that investors and market participants should carry on as usual.
First off, a mere 1.80% drop in the index is far from earth shattering. Until we get into the range of 4%+ declines in one day, there is nothing to panic about. It is also important to remember that while the S&P 500 and Dow Jones remained steady on Friday, the nature of the stocks that make up the NASDAQ are significantly more volatile than the components in the other two indexes. Thus, it is common for the NASDAQ to decline (advance) at much higher magnitudes than other two indexes.
Second, let’s look at perspective. The first chart looks scary. This chart only looks at the last week of trading.
But this second one, which looks at over one year of trading, tells a much different story.
As you can see, in the last year or so, this is the third such decline. So, again, I must ask, what is the fuss about?
Third, and possibly most important, when markets are exhibiting strong momentum – as has been the case for quite some time – it is common to see pullbacks at and around 52 week highs. Behaviorally, the 52 week high becomes an “anchor” for investors. In other words, when stocks near 52 week highs, investors recalibrate their valuations. That is the 52 week high price becomes the baseline and any price higher requires “new” information that confirms a priori beliefs. Note, “new” is not necessarily new information, rather it is any information that confirms their beliefs about the stock price. After the news confirms their a priori beliefs, stock prices continue moving higher as analysts and investors are confident prices should be higher. I suspect this is the case with the NASDAQ and we should see the index climb higher in the coming weeks.
Fourth, carry on.