People want to think market crashes are “caused” by something, and the explanation people have seized on in the aftermath of today’s 999-point plunge (biggest in history) is that some idiot made a typing error.
Some idiot may well have made a typing error–allegedly entering a sell order for $16 billion when s/he meant $16 million. And there may well have been a lot of other electronic trading problems as traders freaked out–stocks trading for a penny, stocks gapping down, and so forth. And these may have contributed to the panic.
But anyone who focuses on what “went wrong” with systems or trading errors is missing the forest for the trees.
More than an hour after those freak “trading errors,” the DOW closed down 350–a very sharp decline. The DOW is now off more than 800 points from its recent peak. After months of lower and lower volatility and more and more complacency, the market’s tone has changed significantly in recent days. And not for the good.
So what’s the real reason the market crashed this afternoon?
Because markets sometimes crash.
Seriously. That’s how markets behave–especially on the downside. And it doesn’t take a long look at the fundamentals to figure out why some traders (sellers) might have been quick to dump their stocks today and lock in their gains. Or why other traders (buyers) might have decided to wait a few minutes to see just how good prices were going to get.
- The 15-month rally off the lows has taken the market up more than 70%, the steepest bull market in history with the exception of the 1930s recovery. To say we’re due for a pullback is an understatement.
- Stocks are about 30% overvalued relative to their long-term earnings trend (Prof. Shiller’s “smoothed” earnings PE)
- The situation in Europe is potentially devastating, and no matter how often a Greek bailout is announced, it quickly becomes clear that, at best, it will only kick the can down the road (and, at worst, it will be rejected and the contagion will spread to countries that are too big to bail out)
- The US still has a massive deficit, a huge debt load, and a 10% unemployment rate
- The US recovery is not the “V-shaped” recovery many bulls were looking for–and many smart analysts expect we’ll see a slowdown in the second half of the year
- US consumers still have debt coming out of their ears, house prices are still 30% below the peak, and the growth in consumer spending has mostly come from government transfer payments
- The impact of the stimulus will peak this quarter…and have less effect going forward.
- The government has NO POWDER LEFT: Interest rates are at zero, and the public has no tolerance for any more bailouts.
Add all that together and can we be confident that this crash was just one of the first legs in another big bear market? No. When it comes to predicting future market moves–especially near-term ones–you can never be confident of anything. But it’s certainly possible.
The point is that the economic fundamentals and stock valuations certainly supported a sharp pullback. Pullbacks, like spikes, can be very sharp–with or without “trading errors.” And based on the fundamentals and valuation, further sharp declines wouldn’t be a surprise.