Last Week's Sell-Off Leaves U.S. Investors in Unfamiliar Territory

Friday's sharp sell-off in U.S. stocks capped a week of heavy losses that has the market in the red for 2010. And that has investors wondering where U.S. stock prices are headed next.

On Friday, accelerating concerns about U.S. corporate earnings combined with newly emergent worries about China's health hit stock prices hard. A 6% drop in the shares of Aloca Inc. (NYSE: AA) helped send the Dow Jones Industrial Average into a 216.90-point nosedive, a 2.1% decline that had it end the week at 10,172.98. The blue-chip average fell 4.1% for the week, its worst weekly performance since February of 2009.

The Standard & Poor's 500 Index lost 24.72 points, or 2.2%, on Friday. It closed at 1,091.76 after losing 3.9% for the week. A slew of analyst downgrades on technology stocks on Friday sent the Nasdaq Composite Index down 60.41 points, or 2.7%, on Friday. It closed at 2,205.29, after losing 3.6% for the week.

So where do stock prices go from here? Some savvy investors say that the global financial crisis has re-ordered the world's financial markets and the global economy. The upshot: Investors will be facing situations that they've rarely - or never - faced before.

Some new research by Bespoke Investment Group appears to underscore that U.S. investors are in unfamiliar territory.

After closing at a bull market high on Tuesday, the S&P 500 dropped nearly 5% in the following three trading sessions, closing more than 1% on each occasion.

During the past two decades, the S&P 500 has had three straight days in which it lost 1% or more only 28 times, Bespoke reports. On the day following this three-day decline, the S&P has posted an average return of 0.97%. And it's posted a positive return 65% of the time.

Over the next week, the S&P has posted an average gain of 1.6%. Over the next month, that average gain has been 2.76%, Bespoke said.

Since the bear market began in 2007, this three-day decline has occurred 10 times now. The average next-day return: 0.17%. Over the next week, stocks have actually suffered a decline - in this case (-)2.85%.

But there was also a wildcard last week: The S&P established a bull-market high on Tuesday.

According to Bespoke, since 1927, U.S. stocks have established a 52-week high and then gone down 1% or more for the next three days on only two prior occasions:

  • This happened in July of 1933: On Day Four, the S&P 500 went up 8.81%. Over the subsequent month, the index zoomed 13.16%.
  • It also happened in October 1979: The index went down 0.24% on Day Four. Over the month that followed, the S&P 500 declined 3.6%.

Money Morning Chief Investment Strategist Keith Fitz-Gerald has repeatedly told investors that the global financial crisis has changed the rules of the game forever. Bespoke's research underscores this view.

"So what we've seen over the last four [trading] days has only happened two other
times in the history of the S&P 500," Bespoke researchers wrote.

S&P introduced its first real stock index in 1923 and unveiled an approximation of the current S&P 500 in 1957.

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.

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