An investor observes stock market at a stock exchange hall on January 4, 2016 in Fuyang, Anhui Province of China. Chinese shares slumped to a halt on the first trading day of 2016. The Shanghai Composite Index down 242.52 points, or 6.85 percent, to halt at 3,296.66. The Shenzhen Component Index fell 1,033.95 points, or 8.16 percent, to close at 11,630.94.
ChinaFotoPress—Getty Images
By Paul J. Lim
January 4, 2016

So much for the January Effect.

Historically, stocks tend to start the new year on a positive tone, in part due to the optimism and bonus money that abounds on Wall Street in January following the holiday break.

Yet the markets began the first trading day of 2016 on a decidedly sour note, with the Dow Jones industrial average plunging more than 450 points, pulling the benchmark index down below 17,000. If today’s trend holds, this will mark the worst first day of trading since the Great Depression in January 1932.

Not only that, Monday’s slide almost surely sets the stage for a new round of handwringing about a possible bear market lurking just around the corner. That’s because years in which the market doesn’t enjoy a so-called Santa Rally in the final five trading days of the year plus the first two trading days of the new year, stocks have experienced a rocky ride.

With Monday morning’s slide, both the Dow and Standard & Poor’s 500 index are now down more than 3.3% during this Santa period, with only around one more trading day to go. It will take a monumental rebound on Tuesday to bring cheer back to the markets.

Who’s to blame for the sell-off?

The natural inclination is to point a finger at China, since a 7% plunge in the Shanghai composite index forced Chinese officials to temporarily suspend trading, sending ripple effects of fear around the global markets. The U.S. isn’t the only market suffering collateral damage. Japan’s Nikkei 225 index fell more than 3% today, while several European markets are also down more than 2%.

Yet there are U.S.-specific reasons for the pullback as well.

The ISM Purchasing Manager’s Index, a key gauge of factory activity, fell in December to its lowest reading since June 2009, when the U.S. economy was still in a recession. “The just-ended year closed with a whimper in U.S. manufacturing, and it should limp into 2016 in similar fashion,” said Michael Montgomery, U.S. economist for IHS Global Insight.

But David Kelly, chief global strategist for JP Morgan Funds, cautions investors not to “react emotionally to short-term market corrections.”

He points out that China troubles sparked a 12% correction in the U.S. market in the late summer, leading investors to pull roughly $45 billion out of domestic equity mutual funds during that stretch. And they have since redeemed an additional $66 billion from U.S. stock portfolios. Yet even including today’s pullback, stocks are up more than 6% since that time.

The fear back then, like today, is centered on volatility in Chinese stocks, Kelly notes. “While investors should be vigilant, it is important not to over-react to market emotion and always ask if the issue at hand fundamentally alters your view of the business prospects of the companies in which you have invested.”

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