Anyone who has actively participated in stock markets over the decades has observed a multitude of manic, euphoric advancing phases but also periods of steep, devastating declines as well. The ebbs and flows of the market, while varied in their intensity and duration have always managed to eventually move higher. When things are good, there’s never an end on the horizon and when things are bad, it also seems as if the gloom will never stop.
Markets are naturally tied to the vagaries and trends of the economy and for the purposes of this discussion, I am referring to the US economy, arguably the main economic engine of the world. The movements of the stock market seldom coincide with the associated news events as they happen; more likely, stock prices anticipate in advance of the unfolding of socio economic dynamics and thus are a predictor of expectations. There is the old chestnut coined by stock traders that you ‘buy on mystery and sell on history’.
A graphic compiled by Sue Chang of Marketwatch only a few years ago, shows the history of the Dow Jones average marked by a list of significant events of the particular epoch.
While the graphic is difficult to read on a smart phone, the salient point is that the ongoing march of the American economy coupled with innovations in technologies and businesses of all kinds have always managed to overcome numerous calamities along the way, whether domestic or global. These include numerous world wars, regional conflicts, banking crises, political dramas, economic crises of other nations and the famous technology bubble of the early 2000’s.
Once mainly a measure of ‘industrial’ stocks, the Dow Jones has changed over the decades as new businesses came to be significant drivers of the American economy. In fact, the constituents of the Dow Jones have changed numerous times over the years reflecting the changing dominance of certain companies during their great growth periods. Today, the Dow represents only a small fraction of stock market activity since the introduction of the Standard and Poor’s 500 index as well as the broader Nasdaq index.
While the indices are different in makeup, they generally move in the same direction and thus collectively they reflect the health of the overall equity markets in the US. We can observe from the graphic above that there have been numerous sell offs in the Dow index over the decades and some of them quite large in percentage terms. The takeaway is that market corrections, bear or otherwise, tend to be relatively short in duration compared to the time that the market spends advancing.
The most recent panic selloff sparked by the supposed existential danger of the Covid 19 pandemic is certainly dramatic, not just in magnitude but in the short amount of time it took to erase trillions of dollars in wealth from investors. The breadth of the decline was such as we haven’t seen for decades. The Dow has suffered in a brief period of time, some of the largest point declines in history including a couple of days of over 2000 points. That sounds like a lot and the scale of money involved is many times what it was 20 years ago, but in 1987, the Dow swooned from 2700 to 1700 in only a few days; a 37% drop in value!
Believe me when I say that at that time, it looked like the world was ending. In the end the selloff was attributed to the mechanics of bank settlements and computer driven derivatives. In reality, the foundations of the economy were stable and as we know, over the ensuing years, the markets went on to continue past the old high and has gone up 10 fold since then.
In our present time, we have suffered a 31% decline from the peak of the Dow up until today’s close and given the amount of money participating today, the losses are in the many trillions of dollars. The psychological damage is immeasurable. As noted, this seems to have all been set off by a panic driven by the perceived existential threat of a global viral pandemic.
I won’t pontificate on the merits of this ‘pandemic’ but at this time the casualty numbers don’t bear out this characterization whatsoever; far from it. Statistically, compared to past viral scares, including SARS, MERS, Ebola, H1N1 and AIDS, thus far this strain of flu doesn’t come close to the mortality toll created by those other breakouts. One of the first clues that this is irrationally driven is the odd rush by the public to hoard toilet paper instead of food.
The sudden social panic has caused a series of dominos to fall creating a self sustaining whirlpool of hysteria. As media jumps on the story as the disaster of the day, officials are forced to issue cautionary warnings, people are advised to isolate, businesses are shuttered for periods, schools are closed and all normal social interactions are stopped. People are pushed out of work as supply chains become disrupted and the panic morphs into a genuine hit on the economy, heretofore running at the best level in decades. The relentless reporting of the market’s decline becomes self feeding as people sell…which begets selling. It’s as if someone lit a cigarette in a crowded theater and someone yelled ‘fire!” The ongoing market selloff seems to be telling us that some real damage will be done to the economy.
As noted in earlier pieces, measuring human behavior is an inexact science and by observing the ongoing price action of the markets in the face of known information, we attempt to map out logical areas of supply and demand. From history, we know that large groups can react irrationally and especially so at times of extreme stress.
We still think that we are within the peak time of panic as indicated by the VIX statistic and that sober minds will assess markets rationally once the hysteria subsides. We will reiterate that this is a time of opportunity and accordingly look for evidence of the change in sentiment. Since the decline was so abrupt, I expect that any bounce will also be sharp. History tells us that prices turn around even in the midst of the most dire news. There is an old Chinese saying that you can’t catch big fish in clear water. That maxim may apply at this time.
This meme appropriately sums up today’s events