On Monday, the Dow Jones industrial average sank more than 223 points, marking the fifth straight day of triple-digit moves in the closely watched benchmark.
Technically, this is just a “pullback,” which is loosely defined as a drop of around 5%.
The S&P 500 index has yet to reach a correction, or a 10% plunge. And the broad market is nowhere close to bear market territory, which is a sustained 20% decline in stock prices.
Still, as MONEY recently pointed out, this bull market is starting to show its age. So it’s hard not to wonder if a bear is lurking.
If you’re worried there are more troubled days ahead for equities, here are five things to watch for in the coming days and weeks:
1) Are companies reporting disappointing earnings results?
“I’d be listening to and watching third-quarter earnings reports,” says Liz Ann Sonders, chief investment strategist at the brokerage Charles Schwab.
Why? First, some companies face a new headwind in the form of the stronger dollar. While the strengthening U.S. currency is a sign of global confidence in the U.S. economy, it creates problems for American businesses. A mighty dollar makes it harder for U.S. exporters to sell their goods competitively overseas, which could crimp corporate earnings growth.
Robert Landry, a portfolio manager for USAA, put it this way:
What’s more, many investors think the stock market — at least prior to this sell off — was getting ahead of itself this year. Indeed, the price/earnings ratio (a common measure used to gauge market valuations) for the S&P 500 index had shot up higher than 18, based on the past 12 months of profits. That’s compared to an historic average of around 15. To justify those higher-than-average P/E ratios, investors want to see higher-than-expected earnings growth rates. The volatility of recent days suggests a worry that the bar’s been set too high.
2) Are commodity prices sliding?
The selloff in blue chip stocks recently has “coincided with mounting evidence of a global economic slowdown,” says Edward Yardeni, president and chief investment strategist at Yardeni Research.
Indeed, the reason why the dollar has been strengthening in the first place is that while the U.S. economy has been improving, Europe and Japan are both perilously close to slipping back into recession — for the third time since the start of the global financial panic.
Yardeni adds that global slowdown fears have grown in recent days as industrial commodity prices, including crude oil, have dropped sharply. (This isn’t a big surprise: Slower-than-expected growth in Europe, China and Japan has led to weaker demand for things like steel, copper and oil.)
David Kelly, chief global strategist for J.P. Morgan Funds, notes that Europe is set to release industrial production figures for August this week, along with data on inflation trends. If there’s even a whiff of deflation in the Eurozone — led by tumbling commodity prices — expect another bout of handwringing on Wall Street.
3) Are small stocks getting mauled?
While investors typically pay more attention to large blue-chip stocks, shares of smaller companies can be a harbinger of things to come for the broad market. Why? Because of their size, tiny stocks tend to be more volatile in general and the underlying companies are more easily rattled by changes in the economy.
The bad news is, the market’s tiniest publicly traded companies are already in a correction, as measured by the Russell Micro-cap Index. And should they slide into an official bear — which could be just days away — things could get really dicey on Wall Street.
Sam Stovall, U.S. equity strategist for S&P Capital IQ, noted that there have been 10 calendar years that small stocks have declined in price since 1979. “Of those 10 times,” he said, nine of the S&P 500’s 10 annual returns were 3.5% or less, and six of the 10 years were negative.” What’s more, for all 10 observations, “the S&P 500 posted an average annual price decline of 4.6%,” he said.
4) How is the Nasdaq composite index holding up?
Another canary in the coalmine for the broad market, according to market observers, is the Nasdaq composite index. Relative to S&P 500 or the Dow, the Nasdaq tends to be made up of slightly smaller, faster-growing and economically sensitive companies. In fact, technology stocks still make up around 45% of the index.
This is why in years when stocks slip, the Nasdaq tends to skid further. This happened in 1994, 2000, 2001, 2002, and 2008.
So far this year, the Nasdaq is close to entering into a correction. Should the Nasdaq’s 8% loss expand to 10% or more, look for more volatility in the S&P and Dow.
5) Is China’s economy growing less than 7%?
Continuing worries about China have contributed to the recent sell off in stocks. China’s economy, which had been growing as fast as 9% in 2012, slowed to 7.5% in the second quarter. That figure is expected to fall even further, to 7.3% in the third quarter. Some economists, in fact, are bracing for 7% growth or below.
Why is this important?
Brian Jackson, China economist for IHS Global Insight, notes that China’s leaders “signaled somewhere between 7% and 7.2% as a ‘bottom line’ for growth to meet job creation needs; IHS estimates that 7.2% is necessary to generate the roughly 13 million jobs annually to satisfy new job market entrants.”
Should GDP growth slip below 7%, policymakers in China may have start thinking outside the box. And Wall Street hates the unexpected — especially when it comes to governments and economic policy.