Why Markets Tumbled

For all of you that just came to my class from Economics...this should make some sort of sense to you.

If not...don't let Moore find out!

From the Economist:

IT APPEARS to be an old-fashioned case of risk aversion. Stockmarkets are plunging (the FTSE 100 was down more than 300 points, or 5% just after noon in London, on Monday January 21st), commodity prices are dropping and investors are flocking to the safety of government bonds and currencies like the Swiss franc and yen. Speculative bonds now yield seven percentage points more than US Treasuries, the highest spread since April 2003.

For some, this merely represents a case of stockmarkets catching up with reality. It is now a year since the subprime crisis first emerged. In that time central banks have cut interest rates, investment banks have announced big write-offs and various rescue packages have been suggested. But the end of the crisis is not yet in sight. Indeed, another leg of the debt crisis may be under way, if problems of monoline debt-insurers (an obscure but important bunch who guarantee the timely repayment of bond principal and interest when the issuer defaults) are not contained. If the American economy is not now in recession, it is close enough not to make a practical difference to sentiment.

For much of past year equity investors knew those salient facts but chose instead to take comfort from three more bullish factors. First was that the Federal Reserve would rescue both the markets and the economy, as it has done so often before. Second, even if the American economy faltered, the rest of the world (particularly Asia) could take up the burden of producing global growth. Third, given the global picture, corporate profits could stay high.

All three assumptions are now coming under question. Although the Fed may cut rates this month, it can take 12-18 months for the effects of monetary policy to boost the economy. On the issue of decoupling, it is not clear that either Europe or Japan can escape America’s gravitational pull. The latest data on Singapore (slowing exports and a decline in fourth-quarter GDP) suggest that other parts of Asia might not escape either. It is significant that emerging markets, which had been outperforming their developed brethren in recent months, are now starting to underperform. On Monday Hong Kong suffered its worst loss since September 11th 2001. As they review the evidence of decoupling analysts are cutting their profit forecasts.

An indication of the change in sentiment came when America's administration announced plans for a fiscal stimulus on Friday. In good times, that would have kick-started a market rally; in the current mood, the package was seen as a sign of desperation.

Share prices have now fallen far enough that European indices are in bear market territory having dropped 20% from their peaks. Indices for smaller stocks in Britain have fallen by a similar amount. However, it takes more than just a big percentage fall for a bear market to be officially under way; the decline also needs to be long-lasting (the 2000-02 decline was a classic example).

The markets have had short-term 20% declines in the past (1998, for instance) only to rebound quickly. Indeed, what was remarkable about the long bull run from March 2003 to June 2007 was that it occurred without any such corrections.

Share prices have fallen so far and so fast that an attempt at a rally seems almost inevitable. What may determine if this is a correction or a bear market is whether that rally can be sustained for more than a day or two.