Why Investors Shouldn't Ignore Thursday's Stock Market Plunge

The S&P 500 dropped 5.9% on Thursday, its worst day of trading since March. The index ticked higher on Friday morning, but DataTrek Research co-founder Nicholas Colas said investors would be wise not to ignore Thursday’s big move.

Why It’s Important: From a historical perspective, Colas said there are typically one of two explanations for a 5% market drop in a single day. First, these days occur when there is a problem with market structure that is frequently compounded by overvaluation of stocks. He said the sell-off in October 1987 is an example of this type of market drop.

Second, the S&P 500 can drop 5% in a single day if investors see a problem with the economy that will require a fiscal and or monetary response, such as the ones the Federal Reserve provided in March of this year.

“It is too early to tell which factor caused today’s selloff or if it was a confluence of both drivers,” Colas wrote in DataTrek’s newsletter.

See Also: S&P 500: The Path To 3,430

What’s Next? One possibility is that a surge in market gamblers and novice stock traders placing no limit overwhelmed the largely-automated Wall Street trading algorithms in recent weeks, driving stock prices much higher than they should have ever been. Another possibility is that the recent spike in COVID-19 hospitalizations around the U.S. triggered the sell-off, which is signaling to Congress that the economic reopening will take longer than previously anticipated and more fiscal stimulus is needed.

“If [Thursday] really is the market’s way of raising the alarm, we’re going to get more down 5% days very soon,” Colas wrote.

Colas is recommending investors with long-term time horizons buy stocks at the close of each day the S&P 500 drops at least 5% from here on out in 2020.

Benzinga’s Take: The 1.4% Friday morning rally in the SPDR S&P 500 ETF Trust SPY isn’t particularly inspiring given the S&P 500 is still on track to finish the week down more than 4.2%. However, a longer-term perspective is extremely important given the market just finished its best 50-day stretch in history and is up 36.7% overall since March 23.

Do you agree with this take? Email feedback@benzinga.com with your thoughts.