FOR most of us, the world probably looks much the same today as it did on Monday. But for millions of investors, large and small, the past 48 hours have seen momentous change as hundreds of billions of dollars have been wiped off the value of share portfolios by sharply falling stock markets. It’s a brave analyst who will predict when the slide will stop or what combination of circumstances — for markets are rarely driven by a single fear — will serve to restore confidence and cause prices to climb back toward the historic new highs where many of them were only a fortnight ago.
And confidence is of course at the heart of the matter. But there are other qualities as well. Greed and ignorance are notable. At some point in every major market boom, the professionals and amateur investors who research and think carefully about where they put their money are joined by hordes of new investors who do not understand what they are doing. They are, however, absolutely sure the equity markets are a place to make rapid and substantial capital gains.
The appearance of this new wave of investors anxious to buy in of course pushes prices up further. As prices rise, largely because of their own arrival in the market, the newcomers congratulate themselves on their timing. They are at the same time generally wrong. It is the wiser investors who have decided that now that the “silly money” has arrived, it is a good time to sell and take their profits. This sell-down will often depress prices and by the time the new arrivals see their portfolio values diminishing, it is too late. Their own panicky sell orders will only drive the indices further down.
It is not, however, all that simple. Programmed trading, whereby sell orders are triggered automatically if a stock falls to a certain price, contributed to the 1987 stock-market crash and for a while trading ran away from humans. The programmed trading software is supposedly much smarter now. But there is a major new ingredient — the hedge fund that could give a deadly boost to a downward market spiral. These funds borrow heavily to invest essentially on market movements. Those who sold the market short in anticipation of a downturn are getting even richer at present. Those who went long, expected the boom to continue, could be in very serious trouble since their short-term borrowings need repaying and could now well exceed the value of the assets they purchased. Hedge fund defaults could transform a collapse of confidence into a panic that might impact the global financial system itself, as lenders find themselves staring at gargantuan bad debts.
Gone it seems are the days when violent equity price falls in some markets could leave others unaffected. In 1987, for instance, the then strong Japanese economy and stock market continued to prosper amid the chaos elsewhere. Today’s market globalization may be an extraordinary achievement but it means that when, as happened this week, the Shanghai stock exchange sneezes, we all sneeze.
