Stocks Didn't Crash Friday, But That's Nothing to Celebrate

Posted by: Ben Steverman on October 24, 2008

Despite all signs to the contrary early this morning, the stock market didn’t crash today. Maybe Monday?

Overnight, Asian stocks plunged, then European stocks followed suit. U.S. stock futures fell so far they hit their downside limits of 6%.

In “the couple hours leading up to the open, people were clearly preparing for Armeggedon,” John Wilson, chief technical strategist at Morgan Keegan, told me.

Those were the headlines U.S. traders saw when they woke up this morning. But by the time they got to work, hung up their coats and sat down at their computers, their mood had shifted. Wilson apparently wasn’t the only person who put in a few buy orders at low price levels, hoping to pick up a few bargains if the stock market went into free fall.

“Random Roger” Nusbaum sounds like he was preparing to do the same — “and then the panic never came or at least not yet,” he writes.

Yes the market opened lower today, but then major indexes gradually clawed their way back up a bit. A 3% or 4% decline for stocks is bad, but it’s nothing compared to the 9.6% sell-off Japan’s stock market saw a few hours earlier.

Here’s the funny thing: I’ve been talking to fund managers and strategists all day, and no one seems to be celebrating today’s escape from disaster.

For one thing, many technical traders seemed to be hoping for a crash. They’re waiting for a decisive day of sheer panic — with the counter-intuitive idea that that’s exactly the moment when it would be safe to start buying stocks again. “The faster the market goes down and washes things out, the faster you get to the bottom,” says Mark Arbeter, chief technical strategist at Standard & Poor’s Equity Research Service. (More from Mark on Oct. 24’s trading session here.)

Instead, this stock market has fallen day after day after day. For technical traders looking for a bottom, there hasn’t been ENOUGH wild panic by traders all heading for the doors at once — just a steady stream of sell orders stretching for weeks.

There seem to be three main reasons for all this day-after-day selling of stocks:

1. Panic/fear
“This has been an irrational market in a lot of ways,” Wilson told me. Many stocks and other financial assets are trading at levels that don’t make sense given their likely fundamentals (like earnings).

And some of this fear isn’t unreasonable, at least from a short-term perspective: There could be more serious crises around the corner. Maybe the federal government is on top of problems at U.S. insurance companies or investment banks, but recent events in Argentina, Hungary and Iceland reminded investors that serious trouble can come from anywhere around the world. So some plain old generalized fear might make some sense these days.

2. Forced selling
For the stock market, “the biggest challenge is the mystery around hedge fund redemptions,” says Jim Dunigan, managing executive of investments at PNC Wealth Management. No one knows how much stuff— stocks, commodities, bonds, whatever — hedge funds might still need to unload as fund investors pull out their money. Mutual fund investors are pulling out money too, but hedge funds use a lot of leverage, so they need to sell far more — to both pay off those debts and pay off their customers.

3. Pessimism on the economy
A U.S. recession? We know that already. Credit crunch? That’s getting a tiny bit better, thank you.
No, the real economic worry seems to regard emerging economies, especially those in Asia and their near neighbors. That’s one reason the Friday’s panic originated in Japan, South Korea and Hong Kong.

Some interesting thoughts on this from Michael Yoshikami, president and chief investment strategist at YCMNET Advisors:
He told me Asian and emerging economies eventually will become “a dominant force” in the world economy. But for now, “much of their fortunes are tied to developed nation’s economies.” When the U.S. and Western Europe stumble, countries like China may feel it far more than anyone expected. Emerging economies “probably have gotten ahead of themselves,” Yoshikami says. Commodity markets hit new highs this year on the expectation that “emerging economies would just inhale commodities forever.” On Friday, OPEC cut production of oil, and the price of crude dropped yet again. “It’s not a supply issue, it’s a demand issue,” he says.

For stocks, it’s a demand issue too. No one seems to want any.

UPDATE: Some extra perspective on Oct. 24’s trading session after the jump…

Floyd Norris compares the market's performance so far in September and October with other big two-month declines in history. He comes away reassured:

Is the threat to civilization comparable to the spring of 1940, when Germany conquered western Europe? Is the current period really worse for Nasdaq companies than the bursting of the tech bubble in 2000 and 2001? If the answer to those questions is no, then perhaps the selling is overdone.

Freakonomics' Steven Levitt asks a great question:

There are many things I do not understand about the financial crisis, but the one thing that currently puzzles me the most is how there have not been dozens of huge hedge-fund failures over the last few months.

Then Levitt's co-blogger notes that hedge funds "are blowing up all over the place."

Hmm. But I do think Levitt has a point: It's surprising conditions haven't been a lot worse in hedge fund world, which also suggests things could get a lot worse in the future.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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