The U.S. stock market has had a brutal few days, culminating in what looked like a full-on crash on Monday morning, as the Dow Jones Industrial Average dropped 1,000 points in minutes.
The market pulled out of that tailspin, but there’s still plenty of fear to go around. But as Franklin D. Roosevelt said “we have nothing to fear but fear itself and panic in the Chinese markets,” or something along those lines.
Fear feasts on ignorance, so let’s try to walk through what’s going on. Once you understand, you might still be scared, but at least you’ll be able to have more concrete nightmares.
What is happening in the market?
In a word: carnage.
Prices for investments like stocks and commodities — oil and metals like copper and gold — are dropping sharply around the world. At least one major market — China — is in the midst of an all-out, slow motion stock market crash.
Usually when stock markets are rough, some big investors pull out their money and head for investments for those that are usually safer, such as long-term debt, gold or even stone-cold cash. This is a classic move known as “risk off” — a term that essentially means that people are paranoid right now and don’t want to risk having investments that are sensitive to the global economy.
But there’s a problem. All the havens — the debt, the gold — are not making any money either.
Nowhere is safe. Just above every market in the world has been affected, highlighting that this is not just a problem in Asia or Europe. Investors are expressing a widespread concern about the global economy, which is heavily dependent on China’s continued health.
The declines have been bad enough for some to speculate that we could be in the beginning stages of a full-on market crash.
Why is it happening?
Kate Warne, investment strategist for financial services firm Edward Jones, said that these kinds of dips have historically been a normal part of the stock market.
“What we’re seeing is a return to much more normal market volatility after almost four years of very low volatility,” she said. “While it’s really unpleasant, these types of declines happen generally about once a year. We just haven’t had one for almost four years.”
Markets can be like dominoes sometimes. If they’re set up in a certain way, knocking one over can set of a chain reaction that spreads far beyond the initial move. The first domino, in this case, is the Chinese stock market.
Let’s look at how the other dominoes have been set up.
The U.S., in theory, should be standing strong. The U.S. stock market has been on a tear for the past few years since the 2007-2008 financial crisis, driving the Dow above 16,000. A lot of that is thanks to a strengthening economy — steadily falling unemployment and stronger housing. It’s also had ample support from the Federal Reserve, the central bank of the U.S., which stepped in with a longterm market bailout called “quantitative easing” that has kept interest rates low in an effort to encourage people to spend, buying stocks and consuming goods to fire up the engine of the economy.
Still, the stock market is not the economy.
Let’s repeat that: the stock market is not the economy.
That’s why we usually can compartmentalize crazy stock market movements. Besides, by some other measurements — such as how much money companies are making — a lot of U.S. stocks prices are rather high. Some have even called it a “bubble,” and we all know how fraught that term is.
In China, stocks have also risen at a ridiculous rate. China is a massively important economy due to its size, thirst for resources and spectacular growth. Plenty of people have made a lot of money by investing in China, but recently, its stock market exploded into a full on bubble that everyone expected to burst.
Meanwhile, growth in the U.S. has been tepid, Europe has been dealing with the Greek debt crisis and emerging economies have been unimpressive.
Put simply, there’s just not a lot of people that think the global economy or even the U.S. economy have every reason to keep going at this crazy pace. Just as with people, when you open your eyes to the flaws of the stock market it’s surprising how many problems you see lurking. When the times are good, though, everyone’s too excited to examine what’s going on.
Warne said that the dip is worse because people thought the major world economies were growing, not shrinking.
“I think the main concern is that there are many signs that global growth seems to be slowing and that’s a surprise,” Warne told us.
Why is it happening now?
This is where China comes in.
China is in the midst of a legitimate market disaster, made worse by concerns that the country’s economy — the second largest in the world — is not growing as fast as many had hoped.
The pessimist’s view here is that the damage to China’s economy from its market crash could have major ripple effects around the world.
Meanwhile, things in the U.S. are OK. The American economy is about as strong as any in the developed world. Most of the fundamentals that economists watch — jobs numbers, GDP, etc. — are doing decently. Meanwhile, stock prices have continued to rise despite somewhat tepid profits.
It’s also important to note that this is happening in the summer doldrums. August is historically the most volatile month of trading because there’s just fewer trades being made. As weird as it may seem, there’s a lot of people on vacation, and can mean more dramatic swings.
Nobody can predict the markets (if we could, we would be on a private island somewhere), but the general consensus seems to be that this isn’t going to get that much worse.
JP Morgan analysts wrote in a note on Monday: “Reality Check – market is becoming oversold.” Goldman Sachs analysts also saw an end to the selling, noting that “US economic fundamentals appear stable” and still predicts that the S&P 500 index will hit 2100 by the end of the year, 12% higher than the levels from Monday morning.
Still, Monday morning looked bleak. The Dow Jones Industrial Average lost more than 1,000 points almost immediately, before rebounding a bit. The S&P 500 and the Nasdaq Composite Index of tech stocks were down 4.5% and 6% respectively, huge numbers for those types of broad indexes. Read more…