By: Herbert Diamant
Recently the must-see business news entertainment shows clearly improved their ratings with headlines like “Stock Market Crash” and “Dow Jones Industrial Average index (DJIA) down over 1,000 points”. The only problem was there was no market crash. Furthermore, the headline “Biggest one day drop since 2022” suggests that the writer has almost two years of market experience.
What is missing is some needed perspective. That comes from either having many decades of market experience or working next to a mentor with such experience. Those of us who have lived through several real stock market crashes instinctively know what a real crash is. With the DJIA currently around 39,000, a 1,000 point drop represents a decline of only 2.6%. A move like this could be the start of a correction, but clearly is not a crash. Conversely, it is interesting when the DJIA moves up over 1,000 points in a few days, the news reporters consider that normal.
To me, October 19, 1987 was memorable when the DJIA dropped 508 points. That was a real crash. For perspective, back then the DJIA was at 2,246, so this was a 22.6% decline in one day. Nearly every stock simultaneously dropped over 20%. I remember NYSE specialists calling publicly traded companies for which they made markets, asking them to buy their stock back to stabilize the share prices amid relentless sell orders.
Another memorable decline occurred during the global financial crisis in 2008 when the Treasury Secretary orchestrated the bailout of Bear Stearns and Merril Lynch, but then let Lehman Brothers fail. Market liquidity disappeared across asset classes, including money markets. Although there was an immediate market crash, the correction process occurred over a one-year timeframe, where the stock market declined nearly 60% in value.
More recently, we experienced the uncertainty of the impact of COVID on the worldwide economy. On March 16, 2020, the DJIA fell 2,997 points, which was a 12.9% decline. As with the other crashes, the markets eventually recovered as corporate earnings improved and investor confidence was restored.
What triggered the recent 2.6% decline in one day? There are several parts to the answer. First, over the last 18 months, the market steadily climbed higher without any correction, which is abnormal. Both institutional traders and the retail investor were convinced that markets would continue to always move higher, as if there was no risk of buying into a fully valued market. Second, there was a currency component, where hedge fund traders used leverage by borrowing cheap Japanese currency to finance their trades. When that currency hedge started to unravel, the hedge funds simultaneously unwound positions. The resulting volumes spiked volatility indexes and pummeled the Japanese markets. Third, retail investors panicked. Brokerage firms have given the retail public instant access to live market conditions via apps on their cell phones, so they can instantly react to news headlines by selling. Wall Street loves it when this happens, because they profitably trade against the retail orders.
Markets periodically correct, especially in a fully valued market. When the market steadily moves higher without any meaningful correction for a long time, it is not unreasonable to expect a 10% to 15% correction. This is the way markets work. Some of the newer market participants are learning this lesson the hard way. Meanwhile, we patiently wait for real opportunities to occur when a fundamentally strong company experiences a substantive decline in share price. With a good understanding of risk and return, this brings seasoned market participants into the market to make long term investments.
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