
Interpreting a market plunge - Nuance
https://www.economist.com/blogs/freeexchange/2018/02/crash-course
======
jnsaff2
"But because everyone worries and saves a little more, and invests and spends
a little less, the economy gets stuck in a downturn. Recessions are an
outbreak of collective madness."

Or maybe "Recessions are an outbreak of collective sanity."

------
minikites
You know you live in the best country in the world when rising wages cause the
market to plunge: [https://www.nytimes.com/2018/02/02/business/stock-market-
int...](https://www.nytimes.com/2018/02/02/business/stock-market-interest-
rates.html)

>The immediate catalyst was the jobs report, which showed the strong United
States economy might finally be translating into rising wages for American
workers.

We even punish individual companies for this: [https://www.vox.com/new-
money/2017/4/29/15471634/american-ai...](https://www.vox.com/new-
money/2017/4/29/15471634/american-airlines-raise)

>American Airlines agreed this week to do something nice for its employees and
arguably foresighted for its business by giving flight attendants and pilots a
preemptive raise, in order to close a gap that had opened up between their
compensation and the compensation paid by rival airlines Delta and United.

>Wall Street freaked out, sending American shares plummeting. After all, this
is capitalism and the capital owners are supposed to reap the rewards of
business success.

>“This is frustrating. Labor is being paid first again,” wrote Citi analyst
Kevin Crissey in a widely circulated note. “Shareholders get leftovers.”

------
thisisit
The bigger concern is on the interest rate hikes. Low rates were expected to
help kickstart the economy and prices and wages to increase. What has happened
instead is that all the cheap money has caused asset inflation. US companies
now have record amount of debt.

Too fast increase in interest rates will cause their debt obligations to
balloon and lower profitability. Though this will take couple of quarters to
fully manifest. So, this is just a reaction in line with Amara's law applied
to stock markets- We tend to overestimate the effect of a news item
(technology) in the short run and underestimate the effect in the long run. I
expect media to be soon cheering another round of upward zag.

~~~
fwdpropaganda
You see, the problem that I have with these kind of "explanations", is that
those facts have been around for a long time. Why is it that precisely today
(well, yesterday) was the day that everyone decided "right guys, we're selling
equities"?

The things you describe explain why people keep their finger hovering over the
"sell" button, they don't explain why precisely today they decided to press
it.

~~~
adventured
The 10 year treasury yield has recently strongly overtaken the S&P 500
dividend yield. That aggressive shift is guaranteed to end such a bubbly bull
market run.

[https://assets.bwbx.io/images/users/iqjWHBFdfxIU/i9Zchv.nY_N...](https://assets.bwbx.io/images/users/iqjWHBFdfxIU/i9Zchv.nY_Nk/v2/-1x-1.png)

The treasury move since September is one of the most aggressive of the last
five years.

What happened is simply an inflection point. Markets operate heavily by
trigger points. Those are getting taken out, sparking reactions (selling,
asset allocation adjustments). The Dow went up three thousand points in two
months, after the market was already at bubble price levels on multiples.

Shiller PE:

[http://www.multpl.com/shiller-pe/](http://www.multpl.com/shiller-pe/)

These valuation levels are batshit crazy. It doesn't take much to crash
something that over-extended.

Let's be realistic here. Where was this market going from there? Dow 36,000 by
2019? A 45 PE for the S&P 500? It'll already take ten years of 3% US GDP
expansion and higher global growth to bring the S&P's earnings multiple back
to being close to reasonable.

~~~
Economics4u
Why look at dividend yield when many large companies pay no dividends? The
earnings yield on stocks is a bit over 5%. The 10 year isn't even 3%.

~~~
fwdpropaganda
I would guess the relevant metric is called "real returns": capital
appreciation plus dividends minus inflation.

------
the-dude
Tldr; we have no idea

~~~
dboreham
I'm surprised that nobody has mentioned what seems to me to be the obvious
precipitating factor: that some guy went on national TV on Jan 30 and boasted
that he was responsible for a massive increase in the stock market. When I saw
that I immediately felt a warm and fuzzy feeling for the fact I had decided
not to buy any stocks (except AMD) over the previous few months. I think that
many people who had only half been following the market heard that claim in
the speech, causing them to pay renewed attention to market values, check on
their portfolio, realize that there was clearly a bubble, then decide to sell.

------
EliRivers
HODL, right!

I am, anyway. The standard advice ("Buy low-cost index funds with dividends
reinvested, keep buying on a regular basis, let it ride and don't worry about
the plunges and the peaks") told us this would happen, and here we are.

 _How_ to interpret it? I'd go so far as to ask _should_ we interpret it? They
get paid for coming up with reasons why things happened (after the fact, I
note, although the Economist has hardened up and just said "nobody knows"). We
[1] get paid for leaving our pennies in low-cost index funds with dividends
reinvested for a decade.

[1] Apologies for the generalisation; I needed a bigger word than "I"

~~~
f_allwein
Had to Google HODL and learned it means 'hold', in the context of crypto
currencies losing value.

Can't comment on that, but for stocks, definitely yes. Historically, the
market has always recovered from slumps. I know this does not mean it always
will, but lots of people dropped out of the stock market after the crashes in
2001 or 2008 - for them, it would have been wiser to hodl.

~~~
pbhjpbhj
The market as a whole recovers, but what proportion of [indexed] stock?

What's the expected recovery time? (Say average for a randomly selected 10
indexed stocks).

FWIW this is an academic enquiry, I'm too poor to gamble.

~~~
mcintyre1994
The idea of an index fund is you're invested in the market as a whole, not a
selection of a small number of stocks. So a good index fund will crash when
the market as a whole crashes, and recover in line with the market. The entire
point is you avoid tying your performance to any selection of say 10 stocks,
and typically an index fund will outperform most professional stock pickers.

~~~
RhysU
I like to think that it's being long on Capitalism.

~~~
makomk
That makes me wonder; how on earth would you take a short position on
Capitalism anyway?

~~~
pbhjpbhj
That's what everyone who makes a fortune on the markets does, they extract
value from the system to create personal wealth. The individuals desire is to
do just that; that's how the system "works".

------
Apocryphon
Here's a question - people often refer to the 2008 recession as a once in a
lifetime event. On what basis do they make that statement- because mortgages
can't possibly pop as massively twice? What's to prevent another industry (in
recent years often rumored to be student loans) from doing the same? Who's to
say not another sector is as rotten as real estate was?

~~~
ChicagoBoy11
Mostly on the basis that it is the only way they can justify to
clients/viewers/etc to "not have seen it." One would very reasonably conclude
that the failure of banks/regulators/analysts to see any of this would likely
be a good sign that they prob. don't really know what they are talking about,
and predicting the market is actually kinda impossible, and consequently the
value they add to their clients is minimal/none. So, in order to not give that
impression, it is much easier to say that your models are in fact correct, but
it just so happens that the financial crises was a "once in a lifetime" event.

~~~
AnimalMuppet
I think it goes like this. The memory of a crisis fades over time - especially
the emotional memory of how it felt to wonder if the world was ending. So the
longer time since the last crisis, the less cautious people are.

You can think of this as a system with gain. As time passes, people are
willing to take more risks, which corresponds to the gain going up. That's
fine... until the gain exceeds unity. Then there's a catastrophe. Then
everyone gets very averse to risk, so the gain goes way down. But as time
passes, it creeps up again...

It's reasonable to call 2008 a "once in a lifetime" event, because there
hasn't been anything like it since the Great Depression. This gives some idea
of the time constants involved. (One of the virtues of our regulatory regime
is that they have managed to increase the time constants. Before the Great
Depression, we used to have events like this every decade or two.)

~~~
ChicagoBoy11
Well, not so sure this is a virtue of the regulatory system -- mind you at the
time there were a ton of regulations contributing to system instability (like
laws preventing interstate banking). Can also be said about this crisis: Had
regulators not been so thoroughly captured, there's an argument to be made
that banks would be a lot more alert to these sorts of systemic risks.

------
EGreg
Guys, here is my analysis (which, after reading this article, may shed more
light on the matters).

We have had an asset bubble due to low interest rates. Because people don't
want to keep money in banks. So we have had a bubble in crypto and stocks etc.

As interest rates rise - and they will, because the government will need to
reload for the next QA or whatever - asset markets will keep taking hits.

The question is - why does the central bank really need to raise interest
rates? Why not just keep things as they are and not load up on QA ammo?

That depends - are you an Austrian economist? :)

~~~
pcnix
Ah, is there anything about Austrian economists I'm missing?

~~~
pbhjpbhj
[https://www.investopedia.com/articles/economics/09/austrian-...](https://www.investopedia.com/articles/economics/09/austrian-
school-of-economics.asp)

>"The Austrian school believes any increase in money supply not supported by
an increase in the production of goods and services leads to an increase in
prices, but the prices of all goods do not increase simultaneously." //

------
dustinmoris
I think we will see a bigger correction very soon. Markets crash periodically
and we haven't had a crash for a while now. A periodic crash is not uncommon
and actually makes a lot of sense when you think about the high level picture
of what really goes on in stock markets. Stock markets are essentially
dominated by greed (to get a higher ROI from stocks than through more
traditional ways) and this greed leads to an increasing over valuation of
assets over a period of time (multiple years). At some point the over
valuation is so big that it becomes very visible to investors, at which point
they get cold feet and start selling, and then... boom.

The markets drop to the point where the majority of investors agrees that the
current valuation matches the expected ROI again and therefore stop further
selling. After a couple years of conservative trading the markets return to
become slightly more optimistic again and the game starts from scratch again.

It is a natural cycle and nothing we can do to change, just embrace a crash
every 10-20 years or so...

[http://macromarkets.ie/wp-content/uploads/2016/09/Asset-
Pric...](http://macromarkets.ie/wp-content/uploads/2016/09/Asset-Prices-
GDP.jpg)

~~~
TekMol

        stock markets are dominated by greed
    

Greed is "an inordinate or insatiable longing for unneeded excess". I doubt
one can show that this is what drives the stock market.

What we probably can agree on is that the stock market is driven by the
actions of many actors who try to maximise the utility value of the assets
under their control.

    
    
        an increasing over valuation of assets
    

We cannot show that assets are overvalued at any time. The value of an asset
is very different to every actor. Everybody puts different expectations into
the assets they control.

Even if we apply some 'simple' mathematical definition like the NPV of future
returns, we could not say if an asset is overvalued in regards to that.
Because the future returns are unkown. And we cannot say in hindsight either.
Because the value of an asset is a statistical function of possible future
outcomes. So the actual outcome does not tell us what the statistical function
looked like.

~~~
dustinmoris
I never said that we can show that an asset is overvalued, I simply described
what actually has happened in the past multiple times and what seems to be
happening again.

The truth is that investors will always pump as much money into a stock as
long as there is still a logical explanation for a positive ROI. However at
some point the stock becomes so hot that the general public will also start
pumping money into it (with the simple hope of making some quick and easy $),
at which point the value will skyrocket even further until there is no logic
explanation anymore and it becomes very difficult to justify the value in any
logical way... and that's when it bursts.

Just look at Bitcoin and tell me I'm wrong...

~~~
TekMol

        I never said that we can show that an asset
        is overvalued, I simply described what actually
        has happened in the past
    

We cannot even say in hindsight what was overvalued. We don't know if an asset
was overvalued in the past. Because the value of an asset lies in the
probability function of the future returns. Which can never be found out.

~~~
danmaz74
In terms of market value, you can say a financial asset was overvalued at time
X if it later decreases a lot in vale, and undervalued the other way around.

~~~
TekMol
What if it does both as most assets do?

Apple was worth $500B in 2012 and $300B in 2013. Does that mean it was
overvalued in 2012? Or was it undervalued in 2012 because it is worth $600B in
2014?

~~~
danmaz74
Most assets do both because most assets, most of the time, aren't
really/severely* under- or over-valued. But in general, a moving average can
help in determining when they were under/over valued.

As a counter-example, an example of "extremely overvalued" in my mind would be
Enron before the fall.

* [https://en.wikipedia.org/wiki/Sorites_paradox](https://en.wikipedia.org/wiki/Sorites_paradox)

EDIT: not so much "determining", but "defining" \- you can only know it ex-
post...

------
reallymental
It's really interesting that the yield curve has risen.

There's been a huge amount of negative sentiment on it's flattening, and more
talk about the bonds being overbought...

China's sell off [0] was interesting and generated a lot of chatter about the
value of the bonds, but it was to serve their interest (S&P lowered their
ratings[0]), rather than them acting on some information.

But now, the yield curve has risen even if it's overbought?

[0]
[https://www.ft.com/content/a1ad3848-ba05-11e7-8c12-5661783e5...](https://www.ft.com/content/a1ad3848-ba05-11e7-8c12-5661783e5589)

------
drawkbox
The tax cuts passed, sell the news. Tax cut hype subsides to actual technicals
again.

Interest rates are going to be increasing, always dings the market and debt.

A re-trench helps the stock buy backs coming from the tax cuts, hedge funds
probably helping engineer that volatility.

------
cs702
The specter of rising interest rates in the US (driven by higher inflation
expectations) appears to be a factor.

Fast-growing companies which are investing aggressively today and whose
profits lie far in the future, in particular, are exposed to rising interest
rates, due to the higher _duration_ of such companies' cash flows. Duration,
for those here who don't know, is a measure of the sensitivity of present
value to interest rates.[a] Duration rises with the amount of time an investor
must wait for cash flows, and vice versa.

For example, the present value of $100,000 of cash flow to be generated in 10
years, if the 10-year rate is 2%, is equal to $100,000/(1.02^10) = $82,000; if
the 10-year rate rises, say, from 2% to 3%, the present value declines to
$100,000/(1.03^10) = $74,000, or _a -10% decline_. However, if the $100,000 in
cash flow is to be generated in 30 years, and the 30-year rate rises from 2%
to 3%, the present value declines from $100,000/(1.02^30) = $55,000 to
$100/(1.03^30) = $41,000, or _a -25% decline_. In this example, an increase in
duration from 10 to 30 years changes the sensitivity of present value to a 1
percentage-point rise in interest rates from a -10% decline to a -25% decline.
The longer an investor has to wait for cash flows, the greater the sensitivity
of present value to changes in interest rates.

 _The same ruthless logic applies to companies._ The present value of
companies whose profitability is in a distant future declines much faster when
interest rates rise than the present value of companies certain to generate
cash flows in the near future. Until recently, due to historically low
interest rates and no prospects for inflation, the stock market has been
rewarding high-investment companies that are sacrificing current profits for
growth. If interest rates continue to rise (along with inflation
expectations), I would expect this pleasant state of affairs to change
abruptly -- in which case, strap on your seat belts!

[a]
[https://www.investopedia.com/terms/d/duration.asp](https://www.investopedia.com/terms/d/duration.asp)

~~~
Talyen42
If you compare something like Netflix or Tesla, whose valuations are based on
the proposition of 10x-ing profits sometime in the future, to something like
Apple or GM, whose profits are here and now and may not even increase, would
that mean Apple/GM (as an example) might fare better while the market adjusts
to rising rates? So far, everything is dropping kind of evenly, it seems, but
wouldn't companies with near term cash flows be worth more in a rising rates
environment?

~~~
cs702
If I'm right about rising interest rates, the present value of companies with
near-term cash flows would decline too, but less than the present value of
companies with far-out cash flows.

------
TekMol
I hold 50% of my assets in shares and 50% in money.

I cannot decide if I should hope for the stock market to go up or down. What
do the wise people of HN think?

~~~
tyingq
Guessing the bottom is hard. Spreading risk, like you have done, is a better
idea. Maybe be more granular than "money market" and "stocks" though. There's
bonds, annuities, real estate, foreign derivitives, and other vehicles too.

~~~
TekMol
You seem to imply that I am looking for investment advice or that my approach
of asset allocation might change. Neither is the case. I will simply continue
to hold 50% in shares and 50% in money.

My question is what is better for me. If stocks go up or if stocks go down.

~~~
tyingq
Ok. Great stock earnings far exceed great money market years. And vice versa
for losses...you're geared for the good times. But you don't want advice, so
I'm a little confused at the redirect.

If this was 2007, you would be screwed for the short term. Like 5-10 years
screwed if you are retirement aged. If not, you're brilliant.

I don't get why the advice to not go 50% stock, 50% money market because it's
too coarse is bad though. It's like betting half/half on black/red in
roulette, depending on the specific timeframe. They usually have opposite (or
close to that) outcomes, except that the stock losses/gains are far more wild
than the money market losses/gains. You're hedging a wild swing with a mild
swing.

------
willvarfar
I can't see this economist article - the usual paywall.

But this short snippet by the BBC explains that the market anticipates that
interest rates will rise as wages rise faster than expected -
[http://www.bbc.com/news/av/world-us-canada-42955578/us-
marke...](http://www.bbc.com/news/av/world-us-canada-42955578/us-market-
meltdown-explained)

~~~
simias
The article mentions that but half dismisses it by saying that nobody can know
for sure:

>The swoon set tongues to wagging, about its cause and likely effect. There
can be no knowing about the former. Markets may have worried that rising wages
would crimp profits or trigger a faster pace of growth-squelching interest-
rate increases, but a butterfly flapping its wings in Indonesia might just as
well be to blame.

------
nurettin
Sales of stocks means that the main market movers want to liquidate their
assets. Escaping a possible crash or fear of overvaluation are not the only
reasons you want cash. You could also be preparing for a huge investment.
Considering how privatized USA is, they could be preparing to invest in some
government related action or venue. This could even mean an impending war.

------
sethgecko
Dow Jones had just had it's biggest intraday drop in history and no one has
any idea why. I blame quants and their trading bots. Nothing makes sense any
more.

------
chmike
I guess some people have borrowed to invest in crypto money, or worse in
stocks, and so need liquidity to anticipate credit raise.

The reason the credit rate might be increased (my guessing) is because lending
money creates vritual money and thus inflation. The other reason is because it
would allow banks to profit from the european economy recovery. America has
currently enough growth to absorb the negative effect of a credit rate
increase.

