How significant was the big stock market "plunge" on Monday?

A handful of negative economic reports were certainly a factor in the market decline on Monday, but that was not the full story. There was not any new news per se. Sure, the NBER Business Cycle Dating Committee officially called the start of the recession to be December 2007, but that was simply consistent with common knowledge. The ISM and construction spending reports were weak, but once again they were not inconsistent with the general view that the economy is weak enough to require $500 billion or more in fiscal stimulus over the next year. The real basis for the sharp market decline was simply short-term technical range trading. The market had drifted higher last week on light volume due to the holidays while many people were off. Lacking further immediate upwards pressure it was only natural for short-term technical traders (including banks and hedge funds) to reverse and bet on a move down. The negative "news" sure helped to accelerate the process, but it was more a matter of short-term momentum traders jumping on the bandwagon rather than any significant change in the economic outlook six to nine months down the road. In addition, plenty of traders are chomping at the bit to "test" the recent market lows. It may take them several attempts over the coming weeks, but they will keep trying.

Short-term traders will keep pushing the market hard one way and then reverse when volume peters out and push hard the other way, and repeat that process over and over. Overlaying this process is any longer-term trend that is gradually evolving. Funds may or may not be net sellers of buyers of stocks, or may be rotating between stocks that have differing weights in the market indexes, but ultimately funds will determine the overall, long-term market trend. In the intermediate term, hedge funds may also place speculative positions to bet on perceived market trends, which may then become self-fulfilling in the intermediate term (four to fifteen months), but not for the long term.

General uncertainty about the economic outlook while the incoming economic team gradually develops its economic recovery plan and then waits until January 20, 2009 to begin implementing it also adds to market volatility, even if it is overall a long-term net positive.

In summary, Monday was simply the kind of trendless market volatility that we should get used to expecting whenever there is significant uncertainty in the economic outlook. In no way did the market activity on Monday represent the longer-term market trend, but it may well represent the level of market volatility that we can expect until the economy is clearly on the mend.

-- Jack Krupansky