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Volatility — What you need to know in markets on Wednesday

Myles Udland
Markets Reporter

Stocks dropped on Tuesday by the most this year.

The benchmark S&P 500 broke its 109-day streak of not losing 1% or more in a single session, while bank stocks got absolutely demolished.

When all was said and done, the Dow lost 237 points, or 1.1%, the S&P 500 lost 29 points, or 1.2%, and the Nasdaq lost 107 points, or 1.8%. The XLF ETF, which tracks the financial sector, fell 2.9%.

This move came during what’s an otherwise quiet week in markets and economics news, with Wednesday being no exception. The main piece of economic data expected out is data on existing home sales for February, while the earnings calendar is fairly quiet.

All the focus, then, should remain in Washington, with lawmakers likely to vote on a health care bill on Thursday.

Stocks drop

In most years, the S&P 500 drops 5% or more from peak-to-trough. After Tuesday’s decline, the index is down about 2% from its most recent high.

This drop, in other words, is normal. And after a period of such relative calm in markets, a 1% decline indeed feels like something bigger.

The prevailing narrative on Tuesday is that increasing fears over economic disappointments from the Trump administration drove stocks lower. With the currently-formulated healthcare bill set to hit the House floor on Thursday for a vote — and appearing likely to fail — concerns around the aggressive timeline for tax reform getting passed have cropped up.

Meanwhile, a flattening yield curve appeared to be putting pressure on financial stocks, with the market’s downward momentum also likely putting pressure on the sector that has been a star performer since the election. Major financial names taking it on the chin on Tuesday included Goldman Sachs (GS), Bank of America (BAC), and Morgan Stanley (MS).

Some analysts, however, are skeptical of the idea that politics was really behind Tuesday’s market action.

In a note published Tuesday afternoon, Marko Kolanovic at JP Morgan said that options expiring last week would “lift the lid” from market volatility and likely lead to a decline in stock prices. And here we are.

“We maintain that the market is entering a vulnerable phase, where increased volatility can further contribute to equity outflows,” Kolanovic writes.

“While we don’t want to minimize the impact of political developments, [Tuesday’s] move was primarily technical and should not be fitted into a political narrative (which in fact was neutral between developments in France and US).”

Analysts at Bespoke Investment Group noted on Tuesday that the S&P 500’s drop was likely to see the index close at non-overbought levels for the first time since early February.

Any close below 2,371 on Tuesday would have ended this streak for the S&P 500. The index closed at 2,344 on Tuesday. (Source: Bespoke Investment Group)

A technical reading of the market, saying the stocks are overbought means the S&P is more than one standard deviation above its 50-day moving average. Or, more simply, that the stock market is significantly ahead of a recent positive trend.

Bespoke added that while conventional wisdom might say market’s resolve lower after breaking a streak of being overbought, the last seven instances of markets breaking this trend have seen stocks gain, on average, 1.6% over the following three months. There have been, however, three instances of markets dropping 5% or more after these trends break, most recently in the summer of 2014.

On the sentiment side, Bloomberg reported Tuesday that a record number of fund managers said U.S. stocks are overvalued. With investors certainly feeling like the market is expensive, then, a sell-off clearly didn’t need much of a spark to get going.

At least for one day.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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