How to understand the fall of the stock markets?

Experts in the psychology of financial markets look at what is fueling the selling frenzy around the world and when investors’ intentions to change direction arise.

If you’re looking for a phrase to describe the current stock market crash, just say “the panic of 2008″

In the past century, the world has seen countless financial crises, economic downturns, and stock market crashes. But the last major event to be called “panic” was the panic of 1907.
If ever it was appropriate to reinstate the term “panic,” now is the time. The stock market’s day-to-day decline is unprecedented.
The S&P 500, the index of the 500 largest capitalizations in the United States, lost more than 26% of its value in six sessions, from October 2 to 9. ING IM’s Brian Gendreau points out that the Dow Jones industrial average, founded in the late 19th century, until that month had never seen six consecutive days of bearish quotations of 1% or more.

Forgetting the Normal

Normally even falling stock markets pause from time to time as vultures rush to buy gold-priced stocks.

Today, the psychology of the market is all at once and also normal.
Whenever the stock market dips – as it has in recent days – “there are tons of sellers,” says Dave Rovelli, managing director of equity trading at Canaccord Adams. “People just want to get out and therefore cut their positions. The panic
on the financial markets as in everyday life is explained by the instinct of survival. “That’s what overreacts,” says Avanidhar Subrahmanyam, a professor and market psychology expert at UCLA’s Anderson School of Business.
It’s not just traders who are scared off, it’s also financial institutions. “It’s a panic that’s not unique to individual investors, but general to the entire financial industry,” said John Merrill, chief investment officer at Tanglewood Wealth Management.
The dysfunction in the credit market means that financial companies no longer trust each other to continue transacting with each other.

Irrational desperation?

Panic is a “situation in which people do irrational things,” says Paolo Pasquariello, a professor at the University of Michigan’s Ross School of Business.

If we stick to this definition, does what is happening right now deserve to be called panic? “It’s hard to say that people are selling because they’re panicking,” Pasquariello said. Selling now isn’t necessarily irrational, he says. There are good reasons to move from risky investments to safer ones at a time when the financial system has shut down and a serious economic downturn seems imminent to many economists.
In contrast, Subrahmanyam is more convinced that markets behave irrationally. It’s not like we had a nuclear war with destruction of real assets, he said. The problems are in the financial sector, not in the “real” activity of the rest of the economy. “The real non-financial base of the economy is still quite strong,” he says, “even stronger than during, say, the Great Depression”.

Business time

“The fall of the markets is not eternal” says Gendreau of ING. Many investors will find that many assets are sold today at discount prices. “Either we’re going into a Great Depression, or some of these assets are being sold at very attractive prices.”

Many market participants believe the wave of equity selling is being driven by hedge funds and other institutions that need to sell to raise capital. Often these assets – from stocks of sound companies to municipal bonds – are sold without regard to their inherent value. But, before going back into the market, “you have to wait and identify the mandatory sell to lead its run,” adds Merrill.

When will this downward spiral end?

Due to our survival instincts, Subrahmanyam says, “Things are very quick to break. but it’s “recovery that takes a lot longer.” »

You first

“The market has bottomed out,” said Georgetown University finance professor Reena Aggarwal. However, “no one wants to be the first to move. Markets are governed by a herd mentality. »
Governments can bring the panic and irrationality of the markets to people who have gone “crazy” This gives them the excuse to intervene and try to restore market confidence in artificial ways such as the recent ban on short selling on financial stocks. The real reasons for the financial crisis “will take a long time to be found and resolved,” warns Pasquariello.
By its nature, a crisis is a moment of uncertainty. It could be months before we know if the markets have sunk due to irrational fear or due to real economic problems. And it’s scary.