Why the stock market dropped

Photo by Wagner T. Cassimiro via Flickr.

The Dow lost almost 1400 points in the last two days, losing 5% of its value. Other commentators will give possible explanations for what happened. However, this post is the only place you will read the actual cause of the drop.

The reason the market went down is that . . .

. . . at the market’s price over the last two days, more investors wanted to sell than wanted to buy.

What a disappointing explanation!

Of course this is true. It is always true. It is how the market works. But what really happened?

Here’s what really happened. The computers that do most of the trading looks at signs from the market and news, and determined that stocks should be priced lower, and sold shares.

Still disappointed?

You want a more real-world explanation?

Well, let’s take a look at some of the reasons that are on offer in the financial news media.

MarketWatch says that investors “freaked out over rising bond yields“:

[E]conomist Oliver Jones of Capital Economics argues that investors are right to be worried and that the market action shows they are starting to factor in the prospect of a U.S. economic slowdown in response to tighter monetary policy by the Federal Reserve. That slowdown, which he expects to take hold in 2019, would also promise to drag down stocks and bond yields.

Let’s be honest here. No one realistically thought the economy was going to grow at 4% indefinitely. The Fed has said it would be raising interest rates, and has consistently done so. So none of the economic news is a surprise. The same article says “There was no clear catalyst for the Wednesday selloff that sent the S&P 500 and the Dow Jones Industrial Average to their biggest one-day drops since February.”

USA Today says this is a “turning point for [the] bull market

Pinpointing major shifts in markets is an inexact science. But some Wall Street pros say the current one has reached a turning point, as the low interest rates that powered stocks higher over the last decade give way to higher borrowing costs and heightened risks. . . .

The debate about whether the market vibe has flipped from bullish to bearish centers around a few key issues: They include risks to the economy caused by a rise in interest rates; trade frictions with China; the recent drubbing of popular technology stocks; and increasingly high investor expectations that could lead to easy disappointment.

Hmm. Trouble with China on trade has been brewing for many months. Why is that effect happening this week? Did the market’s drop cause Facebook and Apple’s drop, or vice versa?

“[H]igh investor expectations that could lead to easy disappointment”? Really? You mean people changed their minds? I think I said that at the top of this post, and you didn’t find it satisfying.

Here’s what Robert Reich said on Facebook:

Why is the stock market dropping? Trump blames the Fed. Others blame Trump’s trade war with China. Baloney. The biggest reason is the moratorium on stock buybacks – a period starting two weeks before quarterly earnings are released during which companies don’t buy back their stock because they have important information about their earnings that’s not yet available to the public, and they want to avoid any whiff of insider-trading.

In most years this blackout isn’t a big deal. But it is this year because stock buybacks have become so important to maintaining share prices. Goldman Sachs estimates that the 500 biggest American companies alone will spend a whopping $770 billion on stock buybacks in 2018. That’s up 44 percent from last year. So a temporary moratorium of buybacks could easily cause the market to plunge.

Talk about baloney. Investors already know about the buyback moratorium. It’s not a secret. That means it was priced into the price of stocks. Stocks may be worth 1% less because of buybacks, but investors knew that a month ago, a year ago, and five years ago. It’s not news, so it’s not what causes a 6% drop in two days.

Personally, I think it was Kanye West using profanity in the Oval Office. Well, maybe not.

Market news is entertainment

Every article about the market includes “one the one hand, on the other hand” type arguments. This stuff is fun to read, but you can’t verify it one way or the other. It’s there because the market dropped and the media needs to have an article about it.

For everyone who says this is a momentary dip, there is someone else who says it is a long-term shift. Who’s right?

Think about this.

If more smart investors thought the market was going a lot lower, it would already be lower. Because they would be selling.

If more smart investors thought the market was going higher, it would already be higher. Because they would be buying.

For everyone predicting up, there is someone else predicting down. That’s how the market works. It balances the two.

I have an opinion about what’s going to happen, but I won’t share it. Why? Because I’m no more likely to right or wrong than anyone else, so my opinion is of little value to you.

Where is the market going next? Here’s some wisdom on Twitter from Nobel winning economist Paul Krugman:

For inquiring minds:

Why did the market suddenly plunge? I have no idea.

Will it keep going down, or bounce back? I have no idea.

Is this going to translate into problems for the real economy? I have no idea.

But what you need to know is: nobody else has any idea, either.

This is the only published opinion I’ve seen that I’m sure is true.

Frustrating, isn’t it?

What should you do?

Should you use these “news” reports to determine what to do with your portfolio? No. You are not smarter than the market.

If you can’t stomach drops in the market, you shouldn’t be in it. Exit. Slowly, please,

If you are in stocks for the long term, hold. A two-day drop doesn’t change anything.

How will you know when to get out? You won’t. That signal you’re looking for, on China trade or bond yields or unemployment numbers or economic growth or Fed interest rate hikes? Are you poised at your keyboard waiting for it? Forget it. The computers that sell stocks will see it before you do, whether that’s a millisecond before or an hour. Whatever it is will drop the market well before you can sell.

I’m bracing myself for your opinions in the comments. But ask yourself as you write: are you posting about what your biases tell you, or do you have some inside information the market doesn’t? Do you believe you know if Trump is good for markets or bad — and if so, is your opinion based on your politics, or some financial modeling that’s smarter than the rest of Wall Street?

It’s a jungle out there. Be careful.

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  1. Best thing I’ve read about the stock market since this whole things started. I have to admit, when I saw your headline I thought to myself, “oh no, please Josh….don’t get on this speculation bandwagon.”. I should have known better. Thanks for cutting through the bullshit. 😉

  2. I’ll be honest: I normally wouldn’t spend time reading about Wall Street. It’s gonna do what it’s gonna do, and my teeny 401(k) isn’t going to pull it out of whatever it’s doing. But I read this because of your overly-bold initial statement: “However, this post is the only place you will read the actual cause of the drop.”

    I knew that, in a blog Without Bullshit, you’d come closer than most.

    Thanks for delivering.

  3. You are exactly right. I spent two expensive years trading options to learn that the future direction of a stocks price is essentially a coin flip. The market runs primarily on emotion, which is impossible to model logically.

  4. Spot on. The truth.

    I once had a wild hair that I would put together a newsletter on the stock market. So, I did.

    The newsletter was boring as my advice was to buy as much of the lowest cost index funds as you can as fast as you can. Feel adventurous? Buy some Berkshire Hathaway for the education and return. And if you want to have a small fun sack of stocks that are sexy or otherwise entertaining, do so. Vices are often nice.

    And then wait until you need the money for something.

    That’s it. It’s all great advice, actually the best advice that money could buy (and it’s free). It’s just not sexy. So, there’s no story, just pure truth. And only stories sell.

  5. Strictly speaking it is not the number of investors on each side, but the amount of money they bring to the table. Also, a lot of these investors have outsourced their thinking to algorithms, which I expect increases volatility, causing this question to be asked more often. So I think it deserves a place in the answer. Not as to direction, but as to magnitude.