Why is the market down today? What’s driving this decline? Here are the Top 5 reasons. And these reasons will hold true even if the stock market goes down tomorrow. Or the day after that. Or the day after that again. And again. You get the idea.
Let’s get into it.
Retail investors – that is, investors like you and me – are at a bit of a disadvantage in many ways.
Some might take this as a confirmation that the markets are, in fact, rigged and that investing is a fool’s errand.
This is simply not the case, and we are adamant that retail investors have some advantages that institutions don’t have.
However, as the markets fall every once in a while, it’s worth reminding ourselves of several of the reasons why the market falls.
This way, we can help ensure we don’t get caught in the emotions that come with those events.
At the end of the day, though, falling markets aren’t a reason to panic. As long as you’ve adopted a strategy that loses less than benchmarks.
Evergreen trees are named because they are green throughout the changing seasons.
In finance, something that is “evergreen” is consistent through changing markets.
Let’s now explain why the markets are down by discussing the top five evergreen reasons.
A Brief Warning Against Market Timing
Let’s start with a quick note about what happens in our heads when markets fall.
Many an active investor has heard of someone who has the holy grail of technical trading strategies that can time the market.
Timing the stock market, as a quick review, is when you:
- buy at the bottom, and
- sell at the top.
Sure, this is the goal of nearly every investment.
But the reality is that market timing is essentially impossible.
No one can tell you when the stock market will turn. Or give you a price that is a sure place where price will turn.
Markets are basically random.
And the only true way to make money in the markets is to invest smartly and base decisions on data.
This usually means holding into investments for a longer period of time.
Top Reason #1: Uncertainty
Investing in the early 2020s was perhaps one of the toughest trials for investors since the 2008 financial crisis.
Even though market timing is impossible, not all investors have a background in studying the markets.
And uncertainty in financial markets gives them a reason to move money into safer assets.
Despite this fact, falling markets are usually a result of larger institutional investors collectively pricing in a bit of short-term uncertainty.
Consider the state of markets towards the end of the year 2021.
The announcement of a new variant of Covid-19, called Omicron, gave markets a reason to hold off on celebrating the end of the pandemic.
As it became apparent that the severity of the new variant is mild, markets began to rebound.
But, of course, what followed in early 2022 was the crisis in Ukraine.
For the most part, markets are priced efficiently.
That means that most things like earnings and other planned announcements have essentially been figured out ahead of time, and analysts have calculated those expectations into their positions.
Whenever news is released that has the potential to upset those expectations, such as the discovery of a new variant of a pandemic-causing virus, those analysts will respond by selling out of positions strategically.
A good – and well renowned/accepted – measure of uncertainty is the VIX Index.
Whenever uncertainty creeps up on the stock market, markets have the potential to respond by entering pullback territory, or about a 5-10% drop.
While the specific percentages can vary from time to time, country to country, you can be sure that as uncertainty increases, stock markets earn “flat” to negative returns.
Top Reason #2: Panic Selling
This section follows uncertainty for a reason. And that is because panic selling typically follows uncertainty in the lead-up to a correction or even a market crash.
Whenever uncertainty turns to full-blown panic, markets and investments tend to fall precipitously.
And it can be shocking to retail investors caught in the middle of it without an idea of what to do.
Stocks are priced to not only show the current values of companies but also the future values that markets believe those companies will be able to return.
This is ultimately because the stock price (for any stock) is based on the present value of future cash flows.
So, an event like the Covid-19 pandemic suddenly catches all investors by surprise and gives everyone a very good reason to be uncertain all at once and in a big way.
Whenever many investors discover their estimates were wrong, and it happens in a very short period of time, this is the leadup to a stock market crash.
This is represented by showing large losses within a single day or a very few days.
When the rest of the market sees these large drops and they start to make the connection that it is because the future is uncertain.
They will follow up with even more selling of assets to save what capital they have left.
This is what’s known as panic selling.
It usually only happens when something dramatically changes in the markets, like for example:
- the ‘discovery’ that internet stocks had no revenue in 2001,
- mortgage-backed securities suddenly being worthless in 2008, and
- the Covid-19 pandemic bringing the world to a halt in 2020.
Top Reason #3: Regulatory Changes
Central banks like the Federal Reserve have enormous powers in the countries in which they operate to affect monetary policy and, in fact, entire economies.
Needless to say, all analysts will follow announcements vigorously.
Most announcements on a central bank’s schedule can result in elevated volatility during that particular day of trading.
This tends to be because investors try to figure out how to respond to reports from central banks.
The data these central banks have and the metrics they review tend to be quite privileged.
Thus, analysts may not know exactly what the focus will be, and this uncertainty can be part of the reason for the volatility.
However, sudden changes in specific verbiage in these reports can give institutional investors reason to respond with even more hesitancy since the tools central banks use can have broad and unknown effects in an economy.
In the general sense, however, stock markets will fall when interest rates rise (or are expected to rise).
This is ultimately because interest rates and stock prices have a negative relationship.
Top Reason #4: Elections and Votes
Some people believe that elections are rigged from the outset, but the market reactions to elections can’t be ignored.
Stable markets depend on the ability to tell what a company will be worth in the future. And government regulation can have an effect on what that value may be.
When a government increases tax revenues on corporations, for example, that will decrease the bottom-line profits that the company is able to report.
Obviously, investors tend to prefer higher profits, so simply increasing taxes might result in decreased stock prices.
Elections, where there are clear changes to the status quo in government, can lead to lengthy periods of increased volatility as markets struggle to figure out where assets should be priced.
This happened in 2016 when Donald Trump unexpectedly won the presidential elections in the US.
And when voters in the UK unexpectedly voted to separate from the European Union.
Top Reason #5: Supply and Demand
Supply and demand are two parts of the most basic economics concept. And it can refer to a few different aspects of the markets.
Supply and demand of assets can cause huge upsets to the status quo keeping prices stable.
This is the case when investors suddenly don’t have an appetite for risky assets. As a result, the demand for those assets decreases, and prices drop.
Supply and demand in the broader sense will also affect asset prices.
When consumers are showing less demand for a particular product, the company or companies that manufacture those products may see prices decrease.
Oil and gas markets tend to be the most exposed to supply changes because the nature of drilling for oil is extremely dangerous and complicated.
In connection with the previous point, it is also heavily dependent on regulatory changes.
How Will The Market Be Different After This?
Okay, now that you understand why the stock market is down today, let’s think about what happens next.
As investors assess the situation further, they will collectively reach one of two conclusions:
- it will get better soon, or
- things are going to get worse still.
If it’s the former, markets will soon see some sort of a rally or increase.
If, on the other hand, investors believe better days are a while away, things might get worse still before they get better.
This will hold regardless of which crisis is driving the current decline.
And it holds whether we’re talking about investors on Wall Street, Dalal Street, the City of London, or anywhere else.
Indeed, this also holds regardless of whether the “Stock Market” in question relates to the Dow Jones, the NASDAQ, FTSE, NIKKEI, Nifty, or any other stock market index.
What’s Next – Why Is The Market Down Today?
Investing in markets comes with a degree of risk, which is the only reason that returns are paid out to investors – it’s because they are willing to take those risks.
Markets tend to fall for a number of reasons.
And it can be difficult to clearly define those reasons until after the markets have already started returning to an upward trajectory.
Once you understand these reasons and what data can help you figure out what might be happening, you can set up your portfolio to not only reduce losses when markets fall but even profit in some cases.
There are strategies that can be learned that will help you with this endeavor.