DOW DROP | Why Now? Top Ten Reasons

Here is the Dow at 3:24 pm. It fell from a high of 25,521 to a low of 23,924,
a record intraday drop of 1,607 points.

The intraday Dow suffered a record point drop of more than 1,600. 

It recovered somewhat, ending the day with a record point drop for the day of 1,175, more than 4 percent.

I am collecting "explanations". Take your pick. Send me an email* on which ones you believe and I will re-rank these reasons to reflect a consensus. 
*john@cityeconomist.com

1. Treasury bond yields have risen sharply in recent weeks. So smart money is betting on higher interest rates. 
2. Outgoing Fed Chair Janet Yellen announced before she retired that the Fed is committed to raising interest rates, so maybe you didn't have to be quite so smart to see this coming.
3. Just a Flash Crash, computer-driven like 2010. Relax, folks, this is a buying opportunity, says one commentator. (But after-hours trading for the first hour showed more selling.)
4. Hey, the market was overvalued, maybe by 20 percent. We knew this was coming.  Investors were just cashing in after the rally in stocks since the GOP victory in November 2016.
5. Friday BLS data showed rise in hourly earnings  for workers. Fed said it saw signs of inflation – i.e., it read the BLS data same as we did.
6. The BitCoin et al. Bubble.
7. Baby Boomers who are retired or are getting ready to are gradually exiting stocks, using the old rule of "100 minus your age" in stocks. Their problem has been where to put their money while they wait for interest rates to rise; rising rates offer more opportunities.
8. A new Fed Chairman creates uncertainty. GOP tax cuts will increase the deficit but mostly won't put money in hands of people who will spend it.
9. A stagnant economy may be in the cards.
10. May be the beginning of a long-overdue corrective bear market.

PBS has since published a list of the Top Five reasons the market is crashing. I have edited the list above slightly after reading this article. 

DOWN DOWS | Cognitive Dissonance 2

July 11, 2008–On Nov. 8 last year, in DOWN DOWS | Cognitive Dissonance  and then on  Nov. 8 in  Huffington Post, I noted that Bob Janjuah of the Royal Bank of Scotland had raised the upper end of his estimate of cumulative subprime write downs. His estimate was $500 billion at a time when losses of just $50 billion were acknowledged by institutions. Now Janjuah looks like an optimist:

1. Bridgewater Associates, the world's second-largest hedge fund, has estimated likely asset writedowns at $1.6 trillion, i.e., a 6 percent overvaluation of $26.6 trillion of risky credit-based U.S. assets (mortgages, credit receivables and credit-card receivables). Some bankruptcies are predicted.

2. David Rosenberg, Merrill's Chief North American Economist, argues in a July slide show that more bad news is in store:
- A recession? We're in it. Just a question of how bad it gets and for how long.
- Asset values? Not yet priced low enough to reflect the recession.
- Housing prices? Could fall another 20 percent.
He therefore believes that while stagflation is the problem today, tomorrow it will be deflation and Fed policy must therefore remain accommodative.

Recent declines in the Dow are closing the disconnect I noted on Nov. 8 between the debt and equity markets. But the months ahead will be challenging for private investors and government officials at all levels.

BUBBLE | Cognitive Dissonance - Equity- vs. Fixed-Income Markets

My point on October 19 about the relevance of cognitive dissonance – which John Tierney has since written about in the NY Times in a non-Wall Street context – continues to apply through two more seriously down Dows, the second of which was the 361-point decline yesterday.

The cognitive dissonance is between signals that securitized subprime losses and other bad news are fully written off/discounted and other signals suggesting that they are not. Or, as a Wall Street trader put it to me at noontime yesterday as we were listening to Fed Governor Kevin Warsh: "The equity markets have been saying one thing and the fixed-income markets another. They can't both be right." Traders make their living by surgically eliminating their preconceptions based on new truth and making swift moves in advance of other investors.

The fixed-income markets were at their most bearish yesterday since August, while equity investors have mostly been hanging on in the hope that the latest Dow drop is the last. Professionals are more wary of "catching a falling knife" by believing that what looks like the end of the bad news really is. I remember that in the summer of 2000, after the disastrous March downfall of the dotcoms, someone was attempting to sell shares in a bottom-fishing hedge fund that would pick up dotcom bargains. Well, the dotcom basement had a sub-basement and even a level B and C below that, as we found out in November 2000 if not before.

The fast-growing Royal Bank of Scotland, fifth-largest bank in the world, takes a surprisingly dim view of how much more in the way of losses remains to be declared. Its chief credit analyst, Bob Janjuah, estimates subprime losses and new accounting requirements (FASB 157, effective Nov. 15, which make it hard to mark Level 3 assets to "make-believe") will bring cumulative writedowns in the $250-$500 billion range. Up till now we have seen at most $50 billion acknowledged. So either RBS exaggerates, or the capital markets have further significant adjustments to make.

DOWN DOWS | Cognitive Dissonance

Oct. 19, 2007–For the day, the Dow fell 367 points or 2.6 percent to 13,522. For the week, the Dow was down 4.1 percent. The other indexes fell by similar percentages. The day had little specific news to drive it. Initial news-service analyses didn’t make much sense, explaining the downdraft based on a few isolated weak earnings reports. The heavy buying of Treasury notes made clear that something more basic was going on – investors were worried and were looking for a safe haven, desperate not to be caught with what they were selling after the market closed on Friday.

Can we explain the week’s drop in the market? Here are two lines of thinking:

1. Investors applied rational expectations theory. The financial community has been providing a stream of information about the subprime loans and some of the information creates cognitive dissonance. Investors take into account all information available and some of the information doesn’t compute. The fact that the FOMC lowered the target interest rate preemptively by 50 points was initially seen as an effort to spur the economy. In retrospect, it can also be seen as an indication of worry on the part of the Fed about credit markets. After the major banks took heavy writeoffs for subprime loan losses, three of them got together to try to bolster the market for structured investment vehicles with a so-called Master Liquidity Enhancement Conduit. This $75 billion conduit raised more questions than it answered. Former Fed Chairman Alan Greenspan opined that the special fund might be counterproductive, contributing to rather than reducing worries about possible further losses. Further losses in the credit markets can be expected to exacerbate problems in the real estate arena, lowering values and discouraging new construction.

2. The madness of crowds and the power of superstition. Today is the 20th anniversary of Black Monday, when the Dow fell 22 percent. The Armenian genocide resolution in the House of Representatives started up a round of international hand-wringing that has raised difficult questions of alliances and allegiances. Turkey is an important friend of Israel as well as the United States. New sabers are rattling in Turkey and Iraq, including a threat by the Kurdish rebels (the PKK) to destroy pipelines carrying oil into Turkey. Add that to a seemingly endless series of U.S. current-account deficits, U.S. budget deficits, declines in the value of the dollar, and a new shifting out of dollars by Asian central banks and it would be easy to see how fears might begin to mount.