Why the Dow Jones Dropped Over 150 Points Today

The Dow Jones Industrial Average fell today as volatility ticked up and financials sold off. In the broader stock market, financial stocks as well as momentum stocks in the technology sector pulled the S&P 500 down. The Dow ended the day down 167 points to 16,245. The S&P 500 finished down 20 points to 1,845.

There was no specific news pushing stocks down, just a general resurgence of fear in the highest-flying parts of the market. For the market as a whole financials and technology stocks led the drop.

Source: Finviz.com.

For the Dow, the drop was concentrated in financial stocks as the Dow's tech stalwarts have remained fairly valued. Despite the daily movements of the market as commentators' and investors' emotions change daily, the story has been the same for a few months now. By many measuresstocks look overvalued. Risks have been growing as debt levels rise and economies around the world slow, so no one should be surprised when there is rising fear in the market.

The S&P Volatility Index is a good way to quantitatively measure the level of fear in the market, which is why it is commonly referred to as the "fear index." The index measures the expected volatility of the S&P 500 over the next 30 days. As the volatility index rises, it means investors as a whole expect there to be larger movements in the stock market.The index was up 10% today to 15.29.

On the Dow Jones today, the biggest movers affecting the index are in financials. While today's worst Dow stock was Pfizer down 2.96% to $31.21, given Pfizer's small stock price the stock is not having much of an effect on the Dow. The biggest effect is coming from financials, particularly Goldman Sachs , down 2.87% to $158.55, and Visa, down 2.05% to $203.45.

Over the past year, the financial sector rose largely in line with the market, yet many argue that the financial sector is undervalued, and for good reason. The financial sector trades at a price-to-earnings ratio of 14.8, below the S&P 500's price-to-earnings ratio of 17.7. The valuation gap has remained as investors remember the pain from the financial crisis and don't want to take a risk on shares in the sector. This is another reason financials frequently lead sell-offs in the market, as investors are wary of what they don't know about financials. That said, if you are an enterprising investor there are some real opportunities in financials, and fears look overblown. Financial companies in the U.S. have rock-solid balance sheets as the Federal Reserve continues to mandate high capital ratios and carefully watches the largest banks' balance sheets through annual stress tests.

While financials as a whole are in a better position than where they were a few years ago, Goldman Sachs' competitive advantages continue to be weakened by the enhanced regulatory scrutiny.

Goldman has always been first and foremost a trading firm rather than a bank. In its heyday, more than 60% of the company's profits before tax came from trading for its own account as well as speculative investments made by the firm's fabled special situations group.

After the financial crisis, new rules and regulations made it significantly harder for banks to own hedge funds and make speculative investments with their own capital. Goldman has probably been hurt the most by this as it was the best at doing so. It was for this reason that Goldman used to be priced significantly above the rest of the banks at a price-to-book ratio of between two and three times book value as Goldman earned far more money on that capital than others.

But the advantage has gone away and Goldman looks similar to other banks. As an article in the Wall Street Journal today points out, "it will be increasingly hard to justify a valuation for Goldman significantly above its tangible book value." Goldman currently trades at a price-to-book value of just 1.07. With an article out in a major U.S. newspaper, it is no surprise the stock was one of the Dow's biggest decliners.

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The article Why the Dow Jones Dropped Over 150 Points Today originally appeared on Fool.com.

Dan Dzombakcan be found on Twitter @DanDzombakor on his Facebook page,DanDzombak. He has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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