Wouldn’t it be great if investors were able to predict when the market would go up, and when it goes down? People certainly try. Whenever significant news happens, you can find commentators on both sides.
No matter what the news is, someone thinks it’s the next 2008, and someone else thinks it’s a booming opportunity. (There are always two sides to any trade, of course.)
The thing is, the short, sharp shocks in the market — the type of single or multiple day moves which really get headlines churning — normally come from strange, unpredictable things: comments or news that take investors by surprise, or involve uncertainty. We don’t know what these things will be ahead of time — if we did, the market would price them in and there wouldn’t be a sudden shock.
[See: 10 Tips for Keeping a Cool Head in a Market Meltdown.]
Just to give a few examples of how arbitrary market-moving news can be:
Grexit uncertainty. In the summer of 2015, Greece’s ability to pay its debt was so uncertain that it was considering leaving the eurozone and reverting to using the drachma as currency. Most Americans had little to no exposure to Greek equities or bonds, but nevertheless, the S&P 500 index (all U.S. companies, by the way) dropped by almost 7 percent in August 2015, when this news was going on. In a happy outcome to this story, just this summer Greece completed austerity measures to restore economic growth — and the eurozone was able to end its financial bailout of Greece. However, even if a Grexit-type scenario had occurred, would this really affect global market fundamentals?
Ebola. In the summer of 2014 markets were seriously spooked by the very real ebola crisis. From a market standpoint, realistically this would only affect biotech and health stocks to some degree. However, the entire S&P 500 dropped by more than 9 percent from Sept. 19, 2014, to Oct. 15, 2014.
Flash crash. Spoofing algorithms caused the prices of several large exchange-traded funds to become unhinged from their true value. Investors saw nearly $1 trillion of value erased from U.S. stocks in just 15 minutes, with the Dow Jones industrial average falling.
Friday the 13th mini-crash in 1989. The Dow fell 6.91 percent on the news of a failed leveraged buyout of United Airlines — one stock. Now, United Continental Holdings (ticker: UAL) makes up just 0.07 percent of the S&P 500.
Fed chair leaving. In early February 2018, Janet Yellen handed over the reins as Fed chairman to a successor. That change in itself can move markets because investors wait for some clarity on how a new Fed chairman will proceed. However it was not just the change at the helm that caused the Dow to drop a record point amount in a single day (over 1,000 points). As she left, Yellen made comments about market and real estate valuations being high, despite knowing how much importance investors place on her comments. These comments caused intense short-term panic in equity markets.
[See: 8 Investing Do’s and Don’ts During Market Volatility.]
Fat-fingered trading errors. Typos happen to everyone, but for traders, they can be extremely costly. For example, in 2001, a London-based trader at Lehman Brothers accidentally keyed in keyed 300 million pounds ($553 million) into his computer during a trade, instead of 3 million ($5 million). Oops. And in 2014, the Japanese stock market was flooded with erroneous trading errors to the tune of $711 billion. These orders were canceled before they could be executed, but that amount is greater than the value of Sweden’s economy.
Circuit breakers. Circuit breakers are a market mechanism used to halt extreme dips in prices. In August 2015, trading was halted 1,200 times in response to fears about China’s economic slowdown. While economic concerns are a legitimate reason to discount prices, the reaction was extreme, and the fact that circuit breakers came into play just exacerbated investor fear levels. By the end of this ordeal, the Dow plummeted over 1,000 points intraday and ended down 588 points, its worst decline since August 2011.
All of these are serious events, to be sure — but they don’t necessarily have long-term, or true market significance. They were freak events that caused short-term panic. In time, markets recovered to more appropriate levels. Remember that equity indexes are made up of baskets of underlying stocks, which represent ownership shares of companies. Whenever market-moving news occurs, consider whether the news would actually have an impact on companies’ ability to do business. Sometimes it may, but more often, markets react simply based on the shocking news, creating a mispricing of the stock’s (or index’s) true value.
Market downturns are completely regular, normal events. Looking back at the Dow since 1948, downturns of 5 percent or more occur, on average, three times a year. Downturns of 20 percent or more occur about once every six years. Of course, these are averages but it goes to show that these are not freak accidents that we all need to panic about.
[See: 9 Value ETFs to Buy for Stability.]
When it comes down to it, equity markets are a trailing indicator of the economy. Not predictive. Unless you think global economies are all going to tank over the long term, be an investor.
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What Will Cause the Next Market Crash? originally appeared on usnews.com
