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Don’t panic about the stock market plunge

6 February 2018

10:47 AM

6 February 2018

10:47 AM

The Dow drops by eleven hundred points, its largest one-day fall ever. Equities around the world crash in sympathy. The bond markets are rattled, picture editors start looking for their stock photos of traders gazing despairingly at their Bloomberg terminals, and anxious-looking analysts turn up on TV warning that a recession might be just around the corner.

True, more than one thousand points off the Dow, and two hundred off the FTSE in the space of a few hours might look scary. To anyone trying to trade it minute by minute it can certainly be nerve-jangling. And yet, in truth there is far less to it than first appears. Over the next couple of years we should probably get used to these kind of violent swings in sentiment. Why? Because the stock markets have become far more automated, and because we are in the late stage of a bull run.

Yesterday’s price moves were certainly dramatic. But they were preceded by something just as impressive, but which didn’t get as much attention. The stock market had been spookily quiet for a very long time. In fact, the S&P 500 had, until yesterday, gone 404 days without a five per cent correction, the longest run of stability ever. It had notched up record runs without so much as a two per cent or even one per cent fall. The explanation? A far larger chunk of the market is now controlled by passive index funds, which invest according to pre-set, computerised rules. In many ways, those are an improvement, and they are certainly far cheaper. But they have one side effect. Price falls get compressed into a single day. The market goes up and up for a couple of years. Then it drops dramatically in a couple of hours as all the black boxes start selling at the same time.

The price moves may have looked huge in absolute numbers, but they were not so impressive in percentage terms. Sure, it was the first time the New York market had been off by 1,100 points in a day. But a 4.6 per cent correction is only the 112th largest one-day fall since New York records began in 1896. At 25,000, it is much easier to lose a thousand points than when the index is at 10,000.

Keep in mind as well that the bull market is coming to an end. Depending on how you measure it, the recovery that started in 2009 is now the third or second longest bull run ever, decisively beaten only by the epic run of the 1990s. As bull markets reach their peak, there are typically more and more violent and sudden corrections. Everyone is waiting for the big downturn, and, at the first sign of it, they all start heading for the exit.

The stock market will crash sooner or later. It always has done in the past, and there is no reason to expect that to stop now. At some point, the global economy will turn down, there will be another recession, and the markets will collapse. But yesterday’s plunge merely signalled the return of volatility. There is nothing to be surprised about in that – indeed, the only real shock is that it took so long to happen.

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