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History in the making: When will the meltdown end?

Aug 10, 2011 @ 3:48 pm

It's challenging — next to impossible, actually — for investors and advisers to have an appropriate level of context for a major market meltdown when we're still caught in the rip tide (and searching for the floor or the shore, whatever comes first).

But in the (at least) 12 trading days since July 25, we've unquestionably experienced one of the most phenomenal market environments on record. The major indexes, of course, have declined roughly 14% in just over two weeks – a period in which we have seen two of the largest single-day point drops in history (with just one day between them, of course.)

But the VIX, or the ‘Fear Index', also tells another important part of the story in the current summer swoon: On Monday, the Chicago Board of Options Exchange Volatility Index spiked a ridiculous 50% in the first day of trading since the U.S. had its credit rating downgraded from AAA status. That registered as the largest gain for the index since February 2007, according to Bloomberg.

The next day — yes, yesterday, even if it feels like it may have been weeks ago — the VIX was down 27%, as markets posted their best day in the last two years.

For context, there was one interview with a Stanford University professor of economics, Nicholas Bloom that helped to put the volatility in some deeper perspective. Prof. Bloom noted that, “stock market volatility is now so high that it's reached the level that occurred right after 9/11, a period of incredible political and economic uncertainty.” (Read the full interview.)

In these periods of ‘uncertainty shock', markets clearly do not know how to react, from one minute to the next. Certainly, on a day like yesterday, there were few who could have predicted that the Dow would close up nearly 430 points for the day — when at roughly 2:45 pm New York time, the index had just dropped 200 points.

A 636-point turnaround in roughly 75 minutes? The optimists saw the Fed's announcement that it would hold rates steady until 2013 as, of course, a positive for helping to stimulate a stalling economy and head off inflation. The pessimists could have easily taken over by reading more into the Fed's statement that “economic growth so far this year has been considerably slower than the committee had expected.” The Fed added that it expects a “somewhat slower pace of recovery over coming quarters,” noting that “downside risks to the economic outlook have increased.”

When announcements that the Fed will effectively do nothing are viewed as positives (at least for the day), it's impossible to understand what's governing market dynamics.

And now, with rumblings about the European debt crisis growing deeper, U.S. banking executives responding to questions about their capital positions, and seemingly every institution and guru projecting the odds of a recession, comparisons to the credit crisis of 2008 are becoming about as common as 100-point swings in the market.

The difference this time around, however, is that this cycle theoretically began because of political, rather than financial dysfunction.

How the current cycle will be remembered in market history will, of course, depend on how it ends. Many seem to be bullish on the longer-term prospects for the market and the economy, given the valuations and earnings of many large companies that are over-sold at levels that have not been seen since 2008, write Dan Jamieson.

But for the short-term — whether that's days, weeks or months from now — it will be impossible to ignore the intense volatility and uncertainty that has gripped global markets. Maybe we should take a lesson from hedge fund manager Stephen Diggle, who clearly took more than a few notes during the 2008 crisis. After Lehman Brothers collapsed, Diggle starting buying farms with his own money, writes Bloomberg, and investment that he now considers the ultimate safe haven.

“We really thought all the investment banks would go under,” Diggle told Bloomberg. “Everyone said, ‘Buy gold.' But at the end of the day, you can't eat it. If everything else goes and I just have these farms, it makes me moderately wealthy.”

Markets just closed. Dow down 520 points, roughly 5% for the day. And dropped more than 300 points during the hour in the time it took to write this post.

Just another day at the ranch.

—M.B.

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