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The 25 Minute Panic

May 07, 2010 12:46 AM ET2 Comments
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From The Daily Capitalist

I have no real explanation for market behavior which caused the twenty-five minute 700 point DJIA drop and 600 point gain. I'm a macro guy. Let the traders figure it out. The most plausible explanation is that (1) the market is overvalued, (2) the markets are nervous, and (3) trading technology got way ahead of the exchanges. I don't buy the story going around that a trader typed in "billion" instead of "million" and brought the market to its knees.

I do recall several panics over the years which left people scratching their collective heads.

In 1962 the market cratered and went down about 25%. My mother told me sometime later that she had sold her stocks because she remembered the depression 30 years ago. I thought she overreacted and told her that we'd never have a depression again because the government was in charge. I believe I was reading Paul Samuelson's book in Freshman Econ 101.

In 1973-1974 the market went down 37%, but took a huge 33% plunge in H2 1974. This was the beginning of stagflation, Vietnam was still going on, and people were confused. For some reason people couldn't understand why we could have inflation and stagnation at the same time. It's kind of funny looking back because we had low industrial capacity during the 1974 recession yet we had inflation. That's confusing to Keynesians.

Then there was Black Monday (October 19) 1987: a 22% drop. Ultimately the market dropped about 37%. This one really felt like a crash. I recall a senior broker telling me about computer program trading that allowed funds to go liquid in an instant. So maybe it all started then. I don't really recall a good explanation of that crash. But I do recall the panic and the feeling: "what's happening?" It was one of those things that you just waited to see how it played out. Beginning of the End? Momentary blip? It's hard to know in the middle of it.

The one thing that is kind of interesting about the Great Crash of 2:42 p.m. is that it was only twenty-five minutes long. In Olden Days it would have cratered the market. But program trading, technology if you will, immediately saw the advantages of the decline and corrected the mistake (if it was one) and the market only closed down 3.2%. Not to say that program traders can prop up a market falling on fundamentals, but it did provide liquidity. Unfortunately liquidity works both ways.



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