The Independent Market Observer

U.S. Stock Market: Should You Be Worried?

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Jun 30, 2015 1:35:00 PM

and tagged In the News

Leave a comment

U.S. stock marketYesterday wasn’t a good day for the stock market—anywhere. When I wrote yesterday’s post, the U.S. markets were only off by a bit. But the drop later in the day looked like it might be a bad sign; at a little over 2 percent, it was the largest one-day dip in some time.

Scary stuff, and to make matters worse, the U.S. indices plummeted below a couple of key support lines, including the 100- and 150-day moving averages. We’re getting very close to the 200-day moving average, my personal trip wire for concern.

It wasn’t just Greece, although that situation alone is troubling. We also had Puerto Rico, announcing its debt is not sustainable, and the Chinese stock market moving into bear market territory. There was a lot to worry about, all coming at once.

Does the market reaction make sense?

When you think about it, though, the reaction in U.S. markets may be perfectly rational. Consider it this way: Stocks should be priced based on their earnings. If expected earnings decline and valuations remain constant, stock prices should decline as well. So far, so fundamental.

Using the S&P 500 as a proxy for the stock market, let's see how that 2-percent drop might, in fact, make sense.

  • About 40 percent of S&P 500 revenue comes from outside the U.S.
  • If we equate a 2-percent drop in the market to a 2-percent drop in earnings (simplistic but reasonable for this kind of top-level analysis), that would mean foreign revenue might be around 5 percent less than expected.
  • Five percent of 40 percent is a 2-percent revenue decline, which brings us back to the 2-percent drop in the U.S. market. (Drops in individual foreign markets were generally larger, reflecting greater potential declines.)

We also need to consider that the market looks forward for earnings. That 5-percent difference is therefore not on current earnings but on expected earnings. If earnings were previously expected to grow 10 percent, for example, then even growth of 5 percent would represent a 5-percent difference from the previous expectation. This adjustment can still allow for continued growth.

I’m playing fast and loose with the numbers here, of course. But the point is that, as an initial reaction, repricing the market to reflect slower growth in the aftermath of the Greek default (not to mention the Chinese market action and Puerto Rico announcement) appears to be a rational response to changing circumstances.

Looks like a normal adjustment to me

Arguably, the downward revision should be larger, and we may yet see that. The fact that the adjustment seems rational, though, suggests that markets may well adjust upward if the damage proves less severe than expected.

In other words, what we’re seeing (at least so far) is a normal adjustment that reflects how the market should be acting. Amid all of the headlines, concern is reasonable, but as of now, there’s really nothing exceptional going on and no reason to worry more than usual.

                      Subscribe to the Independent Market Observer            

Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics

New Call-to-action



see all



The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.


Please review our Terms of Use

Commonwealth Financial Network®