US Stocks Crashed, Then Rebounded, Swinging a Trillion Dollars a Day. How Is This Huge Panic Different From 2008?

Nobody can quite explain the cause yet, but panic and confidence seem to be living side by side.

A photo of a trader with his brow furrowed, a chart of the S&P 500 dropping like a high-platform dive — that was how The New York Times described, on this past Tuesday's front page, the global market turmoil set off by the US stock crash.

The Wall Street Journal's headline was a little misleading, but better at catching the eye: "Dow Falls More Than 1,100 Points, the Biggest One-Day Point Drop in History."

Monday's plunge in the US market wiped out $1.25 trillion of paper value overnight. The press played up the fear right alongside it. The Guardian ran a live blog of photos and text showing readers the pained faces of traders at stock exchanges around the world, even though none of those people can make stocks rise or fall.

Bloomberg's website topped its page with the red that means a bad day in US stocks: "BREAKING: Bloomberg Live TV Is Covering Global Stock Markets." Then it began rolling video coverage. It had finally got the news it was waiting for.

Asian markets open right after the US close. In the early hours of the 6th, Beijing time, Chinese financial news outlets began pushing alerts about the crash one after another: "US Stocks Bloodied Again," "Tokyo Stock Exchange Mothers Index Futures Trigger Circuit Breaker," "US Stock Market Falls Sharply on Monday," "America's Black Monday Reaches the Asia-Pacific."

Wealthfront and Betterment, two services that use artificial intelligence to trade stocks, both had their websites go down for a while. The outage of a customer-facing website almost certainly had nothing to do with their trading, but it still drew a run of coverage.

Read only this much and it would look like another collapse of the capital markets was under way, on the scale of the financial crisis a decade ago. Not many people agree that this is the start of another financial crisis, but the panic has already spread.

The VIX, which measures fear in US financial markets, had doubled from the previous Friday after two days of falling stocks, reaching a high of 38.8 — its highest level since August 2015. The higher the number, the more frightened the market.

In Tuesday's session the three major indices swung harder still: the Dow opened down 2.4%, lurched around all day, and closed up 2.3% — another trillion dollars of value in motion.

Predicting where a market is going is hard. But whether this is a crisis, the end of a party, or a pullback that was due after a long run of gains, the sheer size of today's capital markets means the impact will be unlike anything before it.

In percentage terms, the Dow's 4% one-day drop on Monday doesn't even make the top 100 in history. In absolute terms, that $1.25 trillion equals about one-sixth of everything the stock market shed over the whole 2008 financial crisis.

So how does a swing this large differ, in all its parts, from what happened ten years ago?

The absolute numbers are huge, but Monday's drop is nowhere near past disasters

The Dow and the S&P have had more than 100 single-day drops of 4% or more, most of them during the Great Depression that began in 1929 and the subprime crisis of 2008. The Nasdaq was created later; its worst falls came with the tech bubble of 2000 and the subprime crisis after it.

Against the 6% and 8% crashes of those years, the 4%-plus drop the three indices took on February 5th was not extreme. But the number of index points lost, and the dollars of market value wiped out, really has grown — because there are more listed companies now, and because years of a bull market had pushed the indices themselves so high to begin with.

New York Times columnist Neil Irwin argues that so far the market has fallen back only to roughly where it stood in mid-December, and the decline has not even reached 10%. "People have a cognitive bias where recent events sway their predictions about the future," he wrote. "In fact, the past 18 months have been the least volatile stretch the stock market has had."

Irwin has spent years tracking how governments manage markets. He has interviewed officials at the Federal Reserve and at central banks in several countries, and writes about financial crises, depressions, and the chain of trouble that follows them.

When the economy really is in bad shape, he argues, stocks and bond yields usually fall together. A weak economy cuts company profits, which drags stock prices down. Falling bond yields mean inflation expectations have gone and the Fed is not raising rates, which lifts the face value of bonds and pushes yields down.

What is happening now is the opposite: stocks are falling while bond yields rise.

Look at the market's longer path and, before this sell-off, the S&P 500 had gone 448 straight days without a pullback of more than 3%, the longest such run since 1928. And going back to 1928, the median of the S&P 500's deepest drop within a year is 13.1%. This decline is still a long way from that.

Nobody can explain the crash, but the people actually invested don't believe this is 2008 again

Every time something goes wrong in the stock market, analysts look back for some big number that changed.

The first round of analysis this time was no exception. Some said the market was really worried about rate hikes; others said high Treasury yields were pulling money out of stocks. The employment figures produced flatly opposite readings — some thought the market feared that rising employment would squeeze company profits, others that it feared job growth was slowing.

The uncertainty around the change of leadership at the Fed got dragged in too, of course.

But with no data on who was buying, who was selling, and why, all of this is guesswork by instinct.

As Bloomberg put it, plenty of finance professionals are just scratching their heads over this sudden drop. And rate hikes, Treasury yields, employment — none of these big numbers arrived without warning or was discovered overnight.

When it came to actual trading, though, a good many people threw out the logic of the decline and bought the dip on feel. Human nature won.

Chen Yizhi, who works in the trading department at Citibank in Hong Kong, did not escape this "calamity." He can recall only four index drops of more than 4%: the most recent was the global rout of August 2015, set off by China's slowing economy, and before that "Black Monday" in 1987.

Chen believes rising employment will eventually shape the Fed's decision on rates. If companies need to hire more people, wage costs go up. With US unemployment as low as it is, wages will climb, and costs with them. Inflation follows, and the Fed will certainly step in and raise rates to hold down spending.

But unemployment is very low right now, and there is no sign of any serious crisis in the economy. That is why so many people feel this drop has no real cause and is pure panic.

The violent swings the crash produced were exactly what Citibank wanted. Its recent strategy has leaned on the VIX, trying to make money from market volatility rather than sticking with individual stocks. "In the whole market, the only people who won were the ones trading the VIX. Everyone else lost money," Chen said.

For the wider market, that is not good news. Andre Bakhos, managing director of New Vines Capital, thinks the return of volatility will frighten investors into irrational moves, like selling because everyone else is selling. "Right now this market is driven by fear about interest rates and wage swings, which means good news from here can also be read as bad news."

Stock markets tend to move in step with fear. Bruce Egan studies market volatility at J.P. Morgan in Hong Kong, and the VIX he tracks hit 37% on February 6th. The higher that number, the bigger the swings people expect ahead. That day the VIX reached its highest level since 2015, and its intraday move of more than 100% was the largest since 2011.

Egan calls the market from the start of this year through February "one big bull run," because every stock, on the S&P or in Hong Kong, went in one direction only: up. That is plainly not how stocks normally behave.

"Stocks are supposed to go up and down. A whole year of nothing but up makes no sense," Egan said. Monday's fall was therefore, in his view, "bound to happen sooner or later." It simply came faster and harder than he expected.

The "fundamentals" — the shape of the economy and the underlying condition of industries and companies — gave investors plenty of confidence too. Last Friday the US Department of Labor released employment figures showing wage growth above expectations. Globally, GDP growth has been decent as well. Egan saw "no nasty surprise, no black swan."

That is nothing like 2008, when the nasty surprise was subprime lending, which set off financial risk and a long economic slide.

The big investment institutions made no loud moves on the day of the crash. Inside J.P. Morgan, for instance, Egan received no company-wide memo. He said only the Taiwan business unit took a sizeable loss, because clients there had bought put options; everywhere else came through untouched. "People were fairly calm overall. Business as usual."

Even with words like "crisis," "crash" and "panic" taking over the headlines, the six investors we interviewed came across as remarkably unbothered. Rather than sell, they added to their positions. Most of them read this decline as a natural pullback: stocks had risen for too long, and some of it was coming back.

Yi Mingzhang, an angel investor who has held US stocks for years, tends to think that inflation, plus the short-term optimism that strong employment created, may have led the market to put too high a value on companies. A drop, he felt, was only a matter of time.

That did not stop him from turning aggressive along with the market. He used to put a third of his assets into stocks, and the high-return names he chased — the ones he wanted 50% from — made up only 30% of that.

After Trump took office last year and US stocks rose, Yi became unusually aggressive. He put in more money, and put all of it into high-return stocks: the ones he believed would double in one to two years. "A 10-20% return a year isn't exciting enough for me anymore," he said. "Once you turn optimistic, greed shows up."

And greed usually leads somewhere people would rather not look. Last Wednesday three tech stocks in Yi's portfolio rose a combined 40-50% in a single day, and he began to sense something was off. Gains that large carry the marks of a bubble; he just did not expect it to burst so quickly. "These past two days my portfolio has lost the down payment on an apartment in Shanghai," Yi said. The down payment on the apartment he had his eye on was about 3 million yuan.

Frank Moffitt is a product manager at a startup in Los Angeles. He starts from employment: if jobs improve and people earn more, inflation is unavoidable, which will eat into company profits and eventually hit the stock market.

Last year Moffitt's portfolio was up 20% overall. "Basically all green," he recalled (in US markets green means up, red means down). So he went into 2018 full of confidence.

Then, before clocking out on the 5th, he pulled out his phone and thought his eyes were failing him. "My God, it's all red," Moffitt said. In two months his portfolio had lost 11% of its value.

A lot of it evaporated, but it will not drive him out of the market. "If I were close to retirement, I probably wouldn't put money in stocks anymore. But I've got a long life ahead of me, and I don't think this drop counts as a risk."

Moffitt bought more.

Most of the investors we interviewed bought during the past two days of declines. Judging by how US stocks did on Tuesday, that was the mainstream choice.

On Monday's crash specifically, though, people were not the only force at work.

Twice as much US trading is now decided by computers instead of people as in 2008

"The US Stock Market Belongs to Robots" was the headline on a Bloomberg story last June. At the time, close to 60% of US trading volume came from quant funds and passively managed funds, where computers carried out the buy and sell orders.

Ten years earlier that share was 30%. The investors who run quant funds and automated strategies are mostly institutions, and as algorithmic trading has spread on Wall Street, the institutional share of the US market has risen year after year, from 35% in 2007 to around 45% recently.

The managers of these funds set a trading strategy on a computer and leave the rest to the machine. The moment market conditions meet the strategy's terms, the computer issues the order. It is not ruled by a passing fit of greed or fear the way a human trader is, and it will not fail to carry out the plan it was given.

But if several funds have set similar risk controls, algorithm-driven, computer-executed trades can send large amounts of money in the market rushing the same way in a very short time.

On May 6, 2010, the Dow fell more than 9% in a matter of minutes and a trillion dollars of market value vanished. The market's general belief at the time was that a fault in one trading algorithm had triggered a chain reaction of selling.

The later investigation showed that a British man named Navinder Sarao had built an automated program that generated huge numbers of low-price sell orders, canceled them, and then bought contracts at even lower prices. His trades were fast enough that he used the gap in time to fool his counterparties, and he made about $40 million doing it.

After Monday's crash, some traders again put part of the blame on quantitative and automated strategies.

A few strategists worry that funds using automated trading have multiplied several times over since the financial crisis and could add extra downward speed to stocks during a sell-off, even though the strategies themselves have grown more sophisticated.

Yousef Abbasi, global market strategist at Jones Trading, said: "A few of the fast drops during today's session [Monday's US trading] may have come from computer models carrying out hedges."

As the S&P 500 broke below 2,700, he noted, the selling picked up speed. "The sharp falls and the sharp rebounds both came far too fast. That isn't something human traders could do."

Chris Hempstead, who runs US ETF sales at Deutsche Bank Securities, said ETF trading volume jumped in the afternoon as the close approached, and ETFs accounted for 40% of the market's total turnover for the day, far above the usual 25%.

"We saw an explosion in ETF volume. That is very unusual," he said.

A recent Goldman Sachs report puts the S&P 500 level of 2,735 at the turning point where quant funds switch from buying to selling. On Monday the index fell from 2,750 to 2,649, crossing straight through it, which set off a wave of funds running their sell strategies and pushed the market down faster still.

Compared with 2008, there is no obvious crisis visible outside the stock market

The biggest difference from the crash of 2008 is that back then the crash itself was not the surprise.

US stocks began falling on September 29, 2008, but what shocked the market was not that stocks would drop. It was that the rescue bill, which both presidential candidates supported, was voted down in the House of Representatives. That directly threatened banks already short of cash. And banks carried enormous weight in the US stock market at the time.

None of those conditions exist in 2018.

The Department of Labor, the Department of Commerce, the Department of Energy, the Federal Reserve banks — in short, different arms of the US government take turns putting out all kinds of economic numbers every week.

The prevailing view right now is that the fundamentals of the US economy are in decent shape. Annualized GDP growth in the third quarter of last year was 2.3%, up from 2.2% in the second.

The unemployment rate is at a 17-year low, and hiring figures are strong and still rising. Monthly data the Department of Labor released last Friday showed the US added 200,000 jobs in January and wages grew 2.9%, both the highest since 2009.

Most people with no interest in finance have no idea what these big numbers mean, even though their level really does shape investors' trading strategies, and through them whether the market rises or falls.

Several research firms were uniformly optimistic about 2018. Look at the titles of their reports:

• Goldman Sachs: As Good As It Gets
• Morgan Stanley: (The Outlook Is) Better and Longer
• J.P. Morgan: The Return of the Economic Cycle
• Mizuho: The World Economy Will Keep Expanding in 2018
• Citi: Peak (Economic) Expansion?

In a PwC survey of chief executives at the world's 500 largest companies, the US has now, for the fourth year running, passed China as the country CEOs consider the most important place to invest — and its lead has widened.

There are some worries, certainly. Rising US Treasury yields, for instance, seem to hint that the economy is running hot, that inflation is picking up, and that the Fed may raise rates. Money would then flow out of the market and into banks and other financial institutions, which means tighter liquidity ahead and higher financing costs for companies.

None of this macroeconomic backdrop looks like 2008.

Back then, low interest rates and a flood of foreign money into the US made credit loose and poured fuel on a housing boom.

Low-income people, people with no work, even pet dogs could get home loans of several hundred thousand dollars or more from a bank. All they had to do was state their income; no proof that they could repay was needed — even though many of them could not have paid off the mortgage in several lifetimes.

Once borrowers began to default, small banks were the first to go under, and then the big Wall Street investment banks discovered that they too were holding piles of mortgage debt rated as junk.

Citigroup, Merrill Lynch, UBS and other well-known global financial institutions then took huge losses on subprime loans, and Bear Stearns, the fifth-largest US investment bank, came to the edge of bankruptcy — each of them dragging the others' share prices down toward the abyss.

Congress voted the rescue down, then passed it three days later, then revised it again five days after that and raised the amount to $800 billion — and still the subprime crisis could not be avoided.

The bailout could buy time; it could not fix the problem at its root. Set against the bad products in the junk-bond and derivatives markets, and against a downturn spreading from finance into the entire US economy, $800 billion was a drop in the bucket.

Panic also spread far slower, and far less fiercely, than a decade ago

Before the 2008 rescue bill was voted down, Wall Street's big financial institutions already knew from their own books exactly what kind of trouble they were in.

An internal review at AIG in 2007, for instance, found that it held hundreds of billions of dollars of securities and mortgages, but that in a credit squeeze it would be very hard to sell those assets quickly enough, or at a high enough price.

And if any ratings agency — Moody's, Standard & Poor's — cut its debt rating, it would have to post more collateral against that debt, making things worse still.

But at the time, the expectation of a crash, and the investor panic that would follow it, had not yet reached the stock market.

Before the fall of September 2008, Mark Schmeer, global chief equity investment officer at MFC Investment Management, was still predicting the market would set new highs that year. The strategy research firm ChannelCapitalResearch.com wrote in a Forbes column that January that the strategy for 2008 was to hold on: buy blue chips if the Fed raised rates, buy small caps if it cut them.

On September 15 that year, Lehman Brothers filed for bankruptcy. Its $613 billion of debt made it the largest bankruptcy in American history. Only then did the market accept that the Fed would not ride to the rescue. The $700 billion plan that followed raised hopes and then dashed them. Panic swept through the market, and institutions and individuals alike raced to dump their stocks.

From what is public about this crash so far, there are bulls and bears both, and money is coming in to buy the dip. Several traders and researchers told QDaily that the decline is a natural pullback, with no reason to keep falling. But nobody is speaking in absolutes. All of the world's major indices are down sharply too: Japan's Nikkei 225 fell 7%, and Hong Kong's Hang Seng, the Shanghai Composite, the Shenzhen Component and the main European markets all fell roughly 3-5%.

Ray Dalio, founder of Bridgewater, the world's largest hedge fund, called the sharp index decline a "small correction," and said bargain-hunting money would pour in.

Jurrien Timmer, head of global macro at Fidelity Investments, said he expects the market's fall to stay under 10%. AMP, which manages $150 billion, holds a similar view. Citibank was more cautious, saying only that volatility would last a while.

Robert Pavlik, senior portfolio manager at SlateStone Wealth, said: "I got some buy orders last Friday, and I bought more today. Nothing in the economy has changed between last Monday and today." Barclays, meanwhile, has told clients it will sell $225 billion of stock holdings over the next few days.

The biggest companies today are nowhere near as exposed to the stock market as in 2008

Many banks went under in the subprime crisis of 2008, Lehman Brothers among them. The few that survived paid a heavy price.

Citigroup and AIG were both among the world's ten most valuable companies in 2005. By 2008 Citigroup's market value had shrunk to $100 billion. On March 6, 2009, its shares traded as low as $0.97 intraday, the first time the stock had fallen below a dollar since the company listed in 1986.

AIG's market value fell from a 2006 peak of $190 billion to under $2 billion in 2009.

Others fared no better: Merrill Lynch was bought by Bank of America, Bear Stearns was sold to J.P. Morgan, and US regulators took over Washington Mutual, the country's largest savings bank.

And finance was only the beginning. US listed companies lost nearly $6.9 trillion of market value in that crisis, and plenty of stocks ended up at a tenth or a fifth of their pre-crisis price. General Motors, one of the largest carmakers, filed for bankruptcy and was taken over by the US government — the equivalent of each of America's 300 million people putting in $200 to help GM restructure.

US companies are in far better shape today. As of January 31st, 185 members of the S&P 500 had reported fourth-quarter results for last year, and 80.5% of them beat market expectations — above the 64% average since 1994.

Seven of the ten most valuable companies are tech companies. Their share prices may be overvalued, but their operations will not be touched by a stock market crash any time soon.

Among these giants, every one except Microsoft has kept up average revenue growth of 20% a year. Even Amazon, the fastest at burning cash, posted quarterly profit above $1 billion. Apple, the most profitable of them, posted net profit of more than $20 billion last quarter.

They also have ample operating cash flow and cash reserves. Apple alone holds more than $285 billion in cash — enough, on that number alone, to make it the world's largest hedge fund.

In 2008, banks failed and merged. Today there is no visible reason, in capital or in operations, that could threaten the survival of these big companies.

Companies that run on borrowed money are the ones more likely to be hurt by a crash and a downturn.

At the end of 2017 Netflix had $2.8 billion of cash available. Its long-term debt alone was $6.6 billion, and total debt was over $10 billion.

And while Netflix's subscription business made money last year, operating profit was only $800 million. Had it not managed to issue $3 billion of high-yield bonds, Netflix could not have kept buying and making shows on the scale it does.

But with the market strong, institutions have still been willing to lend to Netflix. The Wall Street Journal argues that the market takes the risk not only for the high yield but because it widely believes that as US stocks climb to record highs, Netflix's market value rises with them — which in turn keeps supporting the bonds these companies issue. A high market value props up the value of the debt.

If the economy worsens, both the bond and the stock market take a hit, which would directly affect Netflix's ability to raise cash. And like every new-tech company, Netflix pays its employees partly in stock options, which are exposed to the same shifts in what the capital markets expect.

Some of that risk has already shown up. After Disney announced it was ending its deal with Netflix and launching two Netflix-like services of its own, Netflix's bond prices dropped sharply. The logic that market value supports bond value is not unbreakable.

Some have raised the US election cycle and the stock market, but no particular Trump effect is visible yet

In his State of the Union address last week, Trump said the stock market had set record after record and that retirement account balances had gone through the roof. "We haven't seen that in a long time!"

He has some reason to be pleased. US stocks are up more than 20% overall since he took office. By Fortune's count, Trump ranks fourth among newly elected US presidents for stock market gains in the first year.

Under the push of his tax reform, cash held overseas will come home. That money can be used for buybacks or dividends that reward shareholders. Apple has already said it will do so; its net cash after debt is now about $163 billion.

This is seen as one of the forces lifting the market. A buyback means fewer shares in circulation: the company's total value stays the same, the share count drops, and the price per share goes up. Good news for anyone already holding it.

The George W. Bush administration tried something similar in 2004, offering a one-time preferential tax rate on repatriated cash. It cut the one-time rate to 5.25% to encourage jobs and growth, with strict rules that the money go into investment, hiring and research.

In the end about 30% of the overseas money came back, and the profits multinationals sent home in 2005 did rise to $300 billion, 3.66 times the $82 billion of 2004. After bringing the profits back, the multinationals bought their own shares, and the US market rose noticeably from 2005 on.

But Chen Yizhi thinks that while Trump's stimulus policies lifted the market when they were first announced, a failure to deliver on them could just as easily become the trigger for a fall.

The macro research team at Tianfeng Securities also takes a cautious view of how much Trump's tax reform will help the market and the economy. They see it as a short-sighted change locked in by political process, in which many of the cuts may accomplish little because of the bargaining behind them. On top of that, by the time the reform passed, the US labor market was near full employment and job growth was slowing. Adding fiscal stimulus at that point could speed up inflation and Fed rate hikes, and end in a collapse in asset prices.

The crash lasted only two days, but volatility is higher than it has been in a year — and it is pulling more people in

"I added this morning. If the open looks good I might add again. I think there's another day or two of falling left. I added about a fifth today," Chen Yizhi told us in an interview on the 6th.

By today's close, with the Dow rebounding, 4 billion shares had changed hands, a near five-year high. Countless investors like Chen rushed in.

Yesterday, as Hong Kong stocks crashed along with US stocks, mainland Chinese investors bought 10.2 billion yuan of Hong Kong shares through the Stock Connect, the biggest single-day figure since the Stock Connect quota was expanded in December 2016.

Steven Leung, executive director at UOB Kay Hian, said: "Southbound money has been holding up the Hong Kong market. Investors are concentrating their buying on Chinese financial companies."

Some people take a week to go from fear to greed. Others need only half a day.

Cover image: US News Money