For the past three years, stock markets have been either placid or up. That is especially true of U.S. stocks, but global markets have largely followed suit. Bonds have been similarly subdued. Over the past two weeks, that calm has been shattered.
Sell-offs happen. It is easy to be calm about that when they aren’t happening. When they actually occur, however, market players have a tendency to freak out. Occasionally, such panics are more than warranted by some shift in the fundamental landscape: an economic collapse, a major war, a natural disaster, a financial implosion. More often, they are triggered by the concern that there is about to be an economic collapse.
The challenge is gauging whether market moves are a weather vane or a head fake. Right now, we are in the midst of a major move down in almost every asset and a major flight to safe havens such as U.S. bonds. Financial news networks and columns are screaming that this might be the big one. While this possibility bears careful attention, for the moment, I’d say that we are in a correction—but not the beginning of something more ominous.
The last major market upheavals occurred at about this time in 2011 and continued until just after Thanksgiving 2011. The issues then were a combination of the downgrade of the sovereign credit rating of the U.S. in the summer and then the serious worry that Greek financial troubles would doom the eurozone. The market carnage and the near freezing of global bond markets only ended when the world’s largest central banks took coordinated action to ensure that at the very least there would be no shortage of money. Since then, save for a brief market sell-off in late spring of 2012 on a flurry of the same eurozone fears and a bond scare in June 2013, interest rates have plunged and stocks have soared.
The proximate reasons for markets acting the way they have the past two weeks are a typically messy mélange. There are new concerns about Europe’s ability to stave off more years of zero growth and deflation. There are also worries about the ending of the Federal Reserve’s multiyear stimulus policy of quantitative easing and about geopolitical anxieties around ISIS in Iraq and Syria, not to mention a mounting sense of unease about the Ebola outbreak. That said, none of those issues suddenly manifested in early October.
Gauging sentiment in marketland is not always easy. Investors often use volatility as a proxy for nervousness, the theory being that when traders and investors become anxious, they start buying and selling more, and more quickly, with a shorter investment horizon. That has certainly been happening the past two weeks in sharp contrast to the past few years, with the volatility index almost doubling.
The plunge in U.S. Treasury yields below 2 percent, the equivalent decline in German bonds below 1 percent, and the concomitant rise in bonds perceived as riskier—such as high-yield debt and emerging market bonds—also indicates that traders and investors are looking for safe havens. The rapid fall in global oil prices over the past month has meant that commodities have also been swept up in the market maelstrom.
Market gyrations such as these are hardly uncommon in the grand scheme of things, even if they’ve been uncommon for the past few years. The unsurprising result is that market participants get lulled into feeling somewhat unprepared, even though they’ve been seasoned by periods of intense volatility such as 2008–2011. Market players are rarely a calm bunch. Though the last few months have been relatively placid, there were nearly constant rumblings that stocks were overpriced, that the calm couldn’t last, that markets were being propped up primarily by the Fed “priming the pump” (a cliché much in favor over the past few years). You would think that market participants would be quite prepared for what is happening now.
But almost no one is ever really prepared, least of all those who buy and sell daily. Some true investors (such as Warren Buffett) are able to take the long view. But daily markets aren’t shaped by investors per se. They are shaped by traders, Wall Street desks (and their European and Asian equivalents), and hedge funds. Financial planners and advisers, as well as the do-it-yourself crowd, hover somewhere in the middle, more likely to buy and sell than sit and hold—but not nearly as likely as the traders and the funds. We know this based on chatter among traders about who is buying and selling, and based on how much volume there is at any given time.
Until the middle of this week, volume has been muted, as it has been before the recent bout of selling. The past few days, it has picked up, indicating that the spread of concern is extending beyond the daily market players. Those movements aren’t atypical for periods of selling, but that’s easy to say when stocks aren’t plummeting and bonds tightening. Even more sanguine voices such as Mohamed El-Erian of Allianz and Jim Paulsen of Wells Capital are warning that more tumult lies ahead.
Of course, most Americans and Europeans, not to mention the bulk of the world’s 7 billion people, have little exposure to the markets, at least not directly. They weren’t breathing a sigh of relief as markets went up the past few years and bonds fell, largely because it didn’t impact their jobs and wages. Those didn’t go up, even if employment trends in the U.S. have improved. And unless the markets do unravel, these weeks of unsettled prices won’t affect them much either, except in the form of lower gas prices (as oil plunges) and lower mortgage rates (as yields drop).
Overall, the world remains much as it was a month ago, just as stuck in lower growth and deflation. Wages remain just as stagnant; corporate profits continue to rise; and in the U.S., the job market continues to improve. Even if a market panic transpires, like all panics, it will burn itself out, though not without some psychological scars and some real drop in assets. And like all panics, it will take on a spectral life of its own and lure us with promises that it is something more and something worse than previous panics. What’s most important is not to succumb to panic’s dark allure.