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No Default - But the market crashed anyway - Outside View

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No Default - But the market crashed anyway
Aug 8, 2011

At the start of last week, many investors and financial analysis were worried about the US defaulting on its debt. The prediction was that if a debt deal was not reached, we'd have a huge market crash around the world. It turns out they were only half right. A deal was made and the US averted default. But the market crashed anyway.

There was not a significant amount of news this week, other than the US debt deal. The explanation given by many is that the market crashed due to worries about a double dip recession in the US and further debt problems in the Eurozone. However, the fact is that this was not new news this week.

US economic data had been slowing for some time - over the last couple of months. Additionally, the Eurozone debt crisis has been going on for over a year. So what went wrong then? Why did the markets have such a large crash this week, despite no obvious trigger?

Unfortunately, there is no simple answer to this. One of the most famous stock market crashes in recent history was Black Monday in October 1987. Global stock markets around the world declined between 20% and 50% in a single day. Until today, there is no generally accepted cause of the crash. Most have blamed program trading and market illiquidity for the crash. Still, nothing related to the fundamentals of the economy or the companies within the stock market.

This week's market crash, like the one in 1987, had no specific trigger. Yes there are concerns about a weakening US economy and the Eurozone debt crisis, but nothing concrete we can point to. In addition, the timing of the crash wasn't related to any specific event. So in trying to answer the question as to what caused the crash, unfortunately there is no clear answer.

The lesson to learn from this is that sometimes markets can have large movements without any specific reason for them. Often it is related to investor panic and herd mentality, both of which can have powerful effects on markets. But why investors panic at the time they do is a still a mystery.

More importantly, crashes like these can provide good trading opportunities. Within the stock market, many companies will have fallen in value even though their fundamentals are unlikely to have been affected. Many commodities have also seen large falls in value, and there are buying opportunities in that space too.

A well-known saying by the famous investor Warren Buffet is to buy when investors are fearful and stay away when investors are greedy. Well, right now investors and the financial markets are quite fearful. So we know what to do.

Disclosure: I do not hold the currency/commodity discussed in this article.

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