James Surowiecki is the guy the New Yorkerpays to explain the economy and the stock market to its readers. This week he explains why the sell-off two weeks ago was not the crash of 1929, which is presumably within living memory for most New Yorker subscribers.
Some of Tuesday’s drama, then, was the result of a mild bout of investor hysteria. But it’s likely that much of it had more sensible underpinnings. While the past few years have been exceptionally good for American companies, with interest rates and labor costs low, and profits at historic highs, a host of potentially huge risks continue to loom, including the threat of terrorism, America’s huge current-account deficit, and the possibility of a slowdown provoked by the end of the housing boom. If investors collectively decided that there was a slightly greater chance of even one of these risks becoming reality, that could have provoked the market decline we saw on Tuesday.
It may seem unlikely that a small change in investor expectations could lead to such a big sell-off. But stock-market investors are trying to predict how much money companies are going to make over the next fifteen or twenty years. Over a period that long, relatively small changes in the present can have huge effects. A ten-billion-dollar company that grows at ten per cent a year for twenty years, for instance, will be, at the end of that period, twenty billion dollars bigger than if it had grown at eight per cent a year. So while big market swings in reaction to poor earnings news or bad economic data often seem exaggerated, evidence suggests that they often turn out to be justified.
At the end of the article James comes perilously close to engaging in the dreaded "healthy sell-off" cliché but manages to avoid it. A couple of good articles like this and we may actually start stealing our neighbors copy on a regular basis again.
Reasonable Panic [New Yorker]