The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

03/16/2020

On October 19, 1987, my boss was winging across the Atlantic on the company plane to honeymoon with his new wife.  Telecommunications in 1987 were relatively primitive by today’s standards, so he was relatively late receiving the news that the Dow just dropped a terrifying 22.6%, almost entirely in the last two hours of trading.  He debated turning the plane around but wisely decided the Crash of 1987 was an irrational problem that had nothing to do with the economy and happily continued on his honeymoon.

The 22.6% is still the all-time record for one day.  Some believe it was caused by mutual funds.  In those days, you could sell a mutual fund over the weekend at Friday prices, and way too many people did just that.  This created a massive sell-off on Monday morning.  That problem with mutual funds has since been corrected.  My opinion is that this was the first crash caused by automated trading or “momentum” trading.  If the market is going up, the computer decides to buy, forcing prices artificially higher.  If the market is going down, the computer decides to sell, forcing prices artificially lower.  As with all sudden drops, the market soon recovered that year.

In the fourth quarter of 2018, the Fed raised rates too quickly and reduced its balance sheet too much.  The stock market promptly dropped almost 20% over the next three months, bottoming on Christmas eve.  Of course, it recovered nicely during the next quarter and soon went on to a series of record highs.  Dropping 20% in three months was scary enough, but the current drop has been 30% in three weeks — just astonishing!

While we don’t know the absolute depth of this market drop, it sure looks like the first half of a V-shaped market drop.  Normally, that suggests a sharp recovery, but I don’t expect that.  The infrastructure damage to the supply chains is not yet well understood.  The bottom of this market cycle will probably look more like an L.  Best case is a U-shaped bottom.

Of course, when will the pain stop?  When will the drop stop?  When the number of new Covid cases flattens!  New cases don’t need to drop — just stop going up.  The former FDA head, Dr. Scott Gottlieb, predicted that will be late next month or early May.   This terrifying market plunge will end, if not soon enough to calm nerves.  Goldman predicts the S&P will recover almost 18% before year-end.  That seems overly-bullish to me, but I’d be surprised if we weren’t close to normal by late summer.

Best Advice:  Stop watching the stock market!!

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