Stock Plunge, Day Two: How the Dow is Dealing with Japan

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It’s more than just what on the floor (Photo: Mike Segar/REUTERS)

For the second day in the row, the US stock market plunged, and then bounced back. Hurt, yes, but shares were not beaten, even as investors had to worry about the double whammy of concerns of nuclear contamination in Japan and a housing report that showed new home construction plunged more than it had in 27 months. On Wednesday, the Dow Jones industrial average dropped nearly 300, before ending the day down 240 points. It wasn’t as big a bounce back on Tuesday, but we still didn’t end the day at the lows, which was a good sign.

Much was the same in Japan, where stocks showed some signs on life on Tuesday, rebounding nearly 6%, for the first time since the quake. Japan’s market is still off 10%, but we are no longer in free fall mode. When you consider the fact that the actual nuclear situation doesn’t seem to be anywhere near stabilized, and that the mood in Tokyo is no better, the fact that the market is taking the news in stride, relatively – remember those 700 point swings at the start of the financial crisis – is a good sign. Here’s why:

Even before the past weeks, most market observers had been expecting a pullback based on the remarkable strength of global equities since last fall. Still, my inbox was filled with warnings from Wall Street mavens, including a wise reminder from Doug Kass about the return of “black swans.” As popularized by Nassim Taleb, “black swans” are severe, disruptive events that aren’t (and to some degree cannot be) factored into markets. The financial crisis of 2008 and 2009, caused by the under-the-radar proliferation of derivatives was one dramatic example, and some have been warning that the current system is no more able to handle those “black swan” shocks than it was two years ago.

January and February were marked by uprisings and revolutions in Tunisia and then Egypt, as well unrest in Bahrain and the Persian Gulf and civil war in Libya that saw sharp spikes in the price of oil. While different in tenor that what is happening in Japan, those events were nonetheless disruptive of the status quo and impacted economies everywhere because of the rising cost of gas and fuel.

Remarkably, however, global markets have digested these events with minimal panic. That is at odds with the daily and often shrill tenor of commentary about the financial impact. As of now, U.S. markets are basically flat for the year, having declined about 5% in the past month. The price of gold (usually a barometer of fear and anxiety) has been up but not spectacularly. Bonds yields have not risen appreciably in the developed world. Credit markets remain functional.

The financial system is no less interconnected now than it was during the financial implosion of 2008. It is more connected than it was in the late 1990s, when the bursting of the telecom and internet bubble saw the Nasdaq index plunged from a high of 5048 in March of 2000 to a low just above 1000 in October of 2002, and that high still has not been reclaimed more than eleven years later. It is more interconnected than it was in 1973-1974, when the first oil shock triggered by OPEC’s embargo led to financial contraction throughout Europe, the United States and Japan.

That interconnection carries great risks – as we saw in 2008 and 2009. There are few circuit breakers in the face of global, synchronous panic in markets. But the interconnection also has the potential to create more stability. That is what many said in the period just before the fall of 2008 – that securitization, derivatives and global flows reduce risk. As we now know, those factors also increased risk that the entire system might sink. But there was more than a kernel of truth in the claims that in a global world of goods and capital, the shocks of what happens in any one place can more readily be absorbed, even as those shocks can act as contagions that under perfect storm conditions can infect the entire system.

What we are witnessing in the past two months is the upside of this interconnectedness. Serious political upheaval, shocks to the global energy system, and a massive catastrophe of both human lives and nuclear disaster have barely been able to rattle global markets. Hundreds of millions continue their march upward in China, India, Brazil et al. A day or days of reckoning may lie ahead but the past few months have signaled that a new chapter may be opening, which also means that the effects of the financial crisis of 2008-2009 may finally be waning.

None of this has any immediate bearing on massive underemployment in the United States; credit and growth challenges in the Eurozone; the evolving effects of food and commodity inflation throughout the world; and what’s happening in Japan. But if recent responses of the financial system are any gauge, it seems we are living in a more stable period than we think, and that at least is a rare piece of good news in an otherwise troubled world.