The Stock-Market Meltdown That Everyone Saw Coming

(Bloomberg Opinion) -- Now seems like the right time to offer an after-the-fact explanation in great detail and with complete and utter certainty of what just occurred in the markets, and why.

Hindsight bias permitting, the factors that led to this sudden and unexpected decrease in share prices are just so obvious. Simple, compelling language describing cause and effect is both comforting and reassuring. The alternative to this soothing narrative is an unimaginable world of random disconcerting events. This stands in stark contrast to how we prefer to see the world around us: orderly, predictable, subject to expert management and prediction.

Sorry, to say, but that isn’t how it works.

We would have shared this explanation before the market dropped, had we been so inclined, but that would have spoiled the fun. Our powers of rationalization are somewhat less persuasive a priori than our overly optimistic belief in our own abilities. Besides, it is much easier to convince you of the reasons for what just happened than persuade of what is about to happen.

Thus, often wrong, seldom in doubt, we opine with great certainty about things of which we know next to nothing. It almost goes without saying, but the less knowledge we are burdened with, the greater the degree of confidence in our forecasts.

Why did the market suddenly drop 3 percent on Wednesday? It is as obvious as the nose on your face that the Fed’s tightening of monetary policy by raising interest rates to curb financial risk-taking is to blame. But we’ve known about this for a while, haven’t we?

As an alternative, maybe you’d like to blame elevated stock valuations, which surely is a valid point in the U.S., except that lagging emerging markets fell just as hard, and they are cheap, very cheap — certainly much less richly valued than U.S. and European markets.

No, you’re all wrong: It’s the trade war started by President Donald Trump. Not only is the U.S. dollar too strong, but tariffs are crushing an already weakened China, which hurts all of its emerging-market suppliers. But we’ve known about this too for a while, haven’t we? 

Wrong again, say the partisan fire-breathers: It’s the Demon-Rats, and the possibility they will take control of the House of Representatives in the midterms, putting at risk all of the Trump pro-growth policies that are solely responsible for the healthy U.S. economy. Again, has anything changed in terms of the electoral outlook?

This market panic — or is it a crash, or a bear market? — was the worst day we have experienced since February of this year. It has now brought markets all the way back to levels not seen since – wait for it – July of this year. Was the market so bad then? This decline follows a market that has tripled since 2009, had zero volatility in 2017, and has continually confounded all experts who in one way or another couldn’t explain why the market was as good as it was.

Just for the sake of a little more perspective: This was the 20th time since the bear market ended in 2009 that the Standard & Poor’s 500 Index had a one-day loss of 3 percent. The Nasdaq-100 Index had its eighth 4 percent down day (although it was the biggest one-day fall since August 2011). Meanwhile, Wednesday’s decline has left the Standard & Poor’s 500 Index all of 5.2 percent below its September high.

True, some stocks were hit much harder than others. Facebook Inc. and Netflix Inc. are now officially in a bear market (if you believe a 20 percent decline is a bear market, but you already know I think that is nonsense).

But enough with facts. Go right ahead and feel free to try on any of your favorite after-the-fact-explanations about why markets fell. It really isn’t that hard. Just take your favorite pre-existing belief system and seek out facts that are consistent with that. Who am I to stand between you and your confirmation bias?

But the reality is simply this: The random walk thesis of how markets move is the best explanation we have. The alternative is looking at these events retrospectively, and from that vantage point they all seem so blindingly obvious. But if they were so obvious, why didn’t we see them coming?

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Barry Ritholtz is a Bloomberg Opinion columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He is the author of “Bailout Nation.”

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