Home > Uncategorized > More thoughts on the stock crash

More thoughts on the stock crash

from Dean Baker

Before anyone starts jumping off buildings, let me give you a few items to think about.

1) The stock market is not the economy. It moves in mysterious ways that often have little or nothing to do with the economy. In October of 1987 it plunged more than 20 percent in a single day. GDP grew 4.2 percent in 1988 and 3.7 percent in 1989. The market did recover much of its value over this period, but we don’t know whether or not it will recover the ground lost in the last week either.

2) The market has gone through an enormous run-up over the last nine years. The current level is more than 230 percent above its 2009 lows. That translates into an average nominal return of more than 14.0 percent annually, before taking into account dividends.

The gains have been even more rapid over the last two years. Even with the recent drop the market is more than 40 percent above its February 2016 level. Most people would have considered it crazy to predict the market would rise by 40 percent over the next two years back in February 2016. In other words, people who have invested heavily in the stock market have nothing to complain about. If they didn’t understand that it doesn’t always go up then they should keep their money in a savings account or certificates of deposit. 

3) This plunge is not in any obvious way linked to higher interest rates. We can say that because interest rates have not risen that much. The yield on 10-year Treasury bonds stands at 2.71 percent. (It fell sharply today as the market was plunging.) That compares to about 2.4 percent a year ago. It’s pretty hard to tell a story that a 0.3 percentage point rise in long-term interest rates will sink the stock market and the economy. The yield had been less than 1.8 percent two years ago.

4) The plunge in markets is world wide with markets in Europe and Asia also sinking sharply. This undercuts the blame Trump story unless the theory is that Trump is so bad he is going to sink the whole world economy. Also, the markets are still above the levels they were at when Trump took office, so this is really not a good theory for Trump critics to embrace.

In short, calm down. The economy is not going to collapse. If you have less money in your 401(k) than you did last week, just remember, you have far more than you expected to have last year.

  1. February 7, 2018 at 5:56 am

    The reason why people are jittery about the stock market is because of the market crash in 1929 that heralded the Great Depression.
    That is not to say that the crash caused the depression.

    Today there are trillions of speculative dollars out there looking for a quick profit wherever there might be opportunity, such as in the stock market. So, a dip in the market will quickly attract some of these dollars. Therefore a major panic is unlikely to occur.

  2. Rob Reno
    February 7, 2018 at 6:30 pm

    The VIX is a measure of how volatile the markets are, and the reason that is important right now is because there are a lot of these very complex financial instruments that let investors bet against the VIX. In other words, when the market is calm and volatility is low, they go up. And when the market is volatile like it was today and yesterday, they go down.
    And these have become a lot more popular over the past few years. Investment funds buy them. There have been estimates that there are a trillion and a half dollars’ worth of these all over the world. And so this has led to some really steep losses this week, and there’s a lot of speculation that it’s responsible for some of the turmoil we’re seeing in the markets. (NPR February 6, 2018, Heard on All Things Considered)

    What are your thoughts in investors betting againt the VIX and purported market turmoil?

  3. February 7, 2018 at 6:30 pm

    I have posted this as a comment to What goes up …
    https://rwer.wordpress.com/author/dfruccio/
    The result was disastrous. I here try again hoping that my table is more readable this time.

    If you believe that stock indices fluctuate according to a normal distribution law (a law most often assumed in financial technology), a fall of 4.6% with compared to a normal deviation of around 1 % is quite astonishing. The index fall more than 4.4% takes place only once for each 500 years. However, the stock index moves according to (truncated) Lévy distribution. It is not rare that we observe a fall more than 6% or more. We must say that this kind of fluctuations is “normal.”

    Here is a list of big fall of Nikkei Stock Average (Nikkei 225). Some others may do the same thing for other stock markets.

    Nikkei stock index 225 (including periods of Dow and Nikkei-Dow indices)
    Date, Absolute points, and the Down fall rate (in percents) 1949-2014

    1.  1987.10.21  21910.08  14.90
    2.  2008.10.16  8458.45  11.41
    3.  2011. 3.15  8605.15  10.55
    4.  1953. 3. 05  340.41  10.00
    5-7. 2008.10.10, 10.24, 11.08  – 9% or more
    8.  1970. 4.30  2114.32  8.69
    9.  1971. 8.16  2530.48  7.68
    10. 2013. 5.23  14483.98  6.98
    11. 2000. 4.17  19008.64  6.98
    12. 1949.12.14  98.50  6.97
    13. 2008.11.20  7703.04  6.89
    14. 2008.10.22  8674.69  6.79
    15. 1953. 3.30  318.96  6.73
    16. 2001. 9.12  9610.10  6.63
    17. 1972. 6.24  3421.02  6.61
    18. 1990. 4.02  28002.07  6.60
    19. 2008.11.06  8899.14  6.53
    20. 2008.10.27  7162.90  6.36

    (Data: My calculation from published data)

  4. February 7, 2018 at 6:30 pm

    Good points Dean. It does seem strange that such small movements on the 10 year US Treasury Bonds, one of the key benchmarks, which ticked up so little, could carry the burden assigned here. But I do think this is about, more than the three days events and the bond movements, the future directions, about the competing paradigms inside the trading world professionals and the economists they listen to.

    Here’s what I said at David Riccio’s post on “What Goes Up…”

    Well, since I’ve stuck my neck out back on Jan. 2, 2018, sensing with the help of Robert Shiller’s data, that something major – a correction or worse was in the cards, date unknown, let me comment on the last three days of trading, Friday Feb. 2 through Tuesday the 6th.

    All the programmed selling and buying makes sorting out a genuine downward trend from short run data very difficult. Yesterday’s resurgence on the DOW of more than 500 points started soon after the opening bell at 9:30 had the market down another 500 points: so huge swings. Many commentators felt it was buying programmed to kick it at a certain trigger point of previous drops which buoyed up the market.

    But I’m trying to reconcile that knowledge with the question: how much of daily trading is driven by this: if it is so powerful in magnitude wouldn’t it forever prevent crashes, as long as enough money was ready to buy; leading further, at what point do client or institutional “nyet’s” disable the automatic buy signal? Thus respecting investors right to say “I’m out of this market?”

    And that line of reasoning leads me to ponder George Soros’ work during the most intense times of troubles, 2007-2009, his “New Paradigm for Financial Markets,” of the “struggle of competing paradigms” as reflected in the trading professionals and institutions, the ups and downs as different explanation theories about where the economy is and going to – fight it out, including an underlying optimism-pessimism frame, and I guess, “correction” falling in between the outright bulls and bears.

    I’m assuming that at some point the new dominant paradigm eventually will be reflected in even the logarithms now dominating the markets. If not, then its even more chaotic and harder to read for outsiders than we think. And Krugman can make all the distinctions he wants that the “trading markets” are not the underlying economy, but sooner or later the two have to reflect each other or we truly have smoke and mirrors – or is just that the 20% will keep jugging along in a permanent boom and the rest of us suffer “what we must” to echo Yanis Varouvakis.

    At this point I can’t tell (Wed. morning NYSE), but in the coming months, say 2-4 out, I’ll bet with Robert Shiller that a serious correction or worse is in our economic future. With feed back loops between the steepness of the drop and the spending inclinations of the top 20 percent, with all due respect to Krugman. And I think he knows that, that there are such loops connecting trading with underlying realities.

    Sorry if I’ve offended techies and trading professionals with my “layman’s” translation here.

    And I could be quite wrong about what is going on.

  5. February 7, 2018 at 6:33 pm

    And Dean, I should have added that my current understanding of the 1987 crash was that if any crash in history could be explained by new IT/programs, and truly severable from the real economy, that was the one. More than happy to hear of other explanations…

  6. February 7, 2018 at 6:45 pm

    Dear Helge Nome,

    It is possible to think like you have written. It is also possible to think oppositely.

    Because “there are trillions of speculative dollars out there looking for a quick profit wherever there might be opportunity,” they are bringing high volatility everywhere there is an opportunity. If this time is safe, it creates another boom and clash. The fact that “there are trillions of speculative dollars” does not assure that the finance market is more safe. It is quite possible that it is more volatile and more fragile.

    • February 8, 2018 at 9:36 am

      I made a spelling mistake. The word “clash” should be replaced by “crash”. Sorry for the mistake.

    • February 8, 2018 at 3:45 pm

      I think the mindset of the speculators is a key to understanding what is happening in the markets today: That mindset is decidedly bullish at this time because a lot of speculators have a lot of money available for gambling. That makes a market crash less likely.

      It is the old story: The small fry panic and run for cover. The big guys laugh and pick up their assets on the cheap.

    • February 8, 2018 at 5:01 pm

      Dear Helge,

      I am talking of a bit different thing. Mindsets of speculators are important for an analysis of a concrete market at a concrete time. However, we should also pay attentions on the objective structure that induces booms and crashes. If a boom ends in a market, the money moves to another and triggers boom and crash. We must pay attentions to this structure. The real problem of financial economy is rather this.

      • February 8, 2018 at 5:53 pm

        We will have to watch the markets and see what happens next.

  7. Rob Reno
    February 7, 2018 at 9:02 pm

    The fact that “there are trillions of speculative dollars” does not assure that the finance market is more safe. It is quite possible that it is more volatile and more fragile.
    ~ Yoshinori

    If I was a betting man I would bet on Yoshinorisan’ wise caution with regards to the linkage between volatility and fragility. If the VIX was intended to be a measure of volatility, but has instead been turned into a trillion dollar casino for speculative investors, are we not transforming a risk measure into a game of risk with radically uncertain potential negative feedback loops? Mind you, I am not saying the VIX speculation is the cause of the latest market volatility, only wondering if there may be some relationship.

  8. Rob Reno
    February 9, 2018 at 12:36 am

    “A group of complete morons” who traded little-known, leveraged products that bet on volatility is “blowing up” everything, Cramer said on “Squawk on the Street.”
    Cramer has been particularly critical of the VelocityShares Daily Inverse VIX Short-Term exchange-traded note, which is traded under the symbol XIV, and those who put money into it. The XIV is supposed to give the opposite return of the VIX, Cboe’s volatility index, which is often referred to as the market’s fear gauge.

    Amid the market tumult, Credit Suisse said Tuesday it will end trading for its XIV later this month after the note lost most of its value and sent investors scrambling for cover.
    “What bothers me is the people who have never looked at a stock and don’t know how to analyze it [are] out in full force today,” said Cramer, host of “Mad Money.” (MSN Money)

    I don’t put much stock in the Cramer’s advice, he is more hype than substance. Interesting the VIX comes up once again. Not sure we will ever know how much it contributed though. But it certainly deserves a look by those whose business it I to know.

    • Rob Reno
      February 9, 2018 at 12:37 am

      Carp! “whose business it is to know.”

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