Make no mistake about it, when we look back at what's happened over the past 10 days, we'll refer to it as the "Crash of 2008," putting it in the same category as the infamous plunges of 1929 and 1987.
As I write, since the end of September, the Dow has tanked some 24%. Shares of General Motors (NYSE:GM) have been cut in half in the past month. Goldman Sachs (NYSE:GS) is down 33% this week alone. Even cash-rich companies that have absolutely nothing to do with the credit crunch are getting killed: Microsoft (NASDAQ:MSFT) is off 20% this week, Google (NASDAQ:GOOG) is off about 17% in the same timeframe. All as I put fingers to keyboard. Perhaps the biggest irony of all is that the only stocks that seem to be showing green this morning are banks, with Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), and Citigroup (NYSE:C) all gaining ground.
It's a mess, that much is clear. But why? What did I miss that's pummeling stocks day after day on what seems to be no news at all?
Panic. Pure, gut-wrenching panic.
It really is about as simple as that: People are panicking. You'll be hard pressed to find someone who can look you in the eye and tell you they've crunched the numbers and concluded stocks are worth 24% less than they were 10 days ago.
The wave of selling we've seen over the past week has little to do with fundamentals and a lot to do with investors wanting to be in nothing but the safest-of-safe instruments, namely cash and gold. In the past week alone, investors yanked some $52 billion out of mutual funds -- on top of the $72 billion pulled out in September. Of course, the managers of those mutual funds have to come up with the cash for their investors, and the only way to do that is to sell stocks and bonds, oftentimes indiscriminately.
Then there are hedge funds. As anxious clients around the globe witness the never-ending sell-off, they want to yank their money out, so hedge funds -- which control trillions of dollars and are coming off their worst month in a decade -- are scrambling to sell whatever they can to cover client redemptions.
It's the leverage, stupid
Couple that with the fact that so many hedge funds employ leverage -- meaning they borrow money to invest with -- and those borrowed funds can be subject to "margin calls," where the banks that lent the money demand more cash as the hedge funds' stock collateral falls in value. Connect the dots, and you get a situation where falling stocks triggers margin calls, which calls for selling, which triggers more margin calls ... you get the idea. What's important is that this type of activity is forced selling, not selling because money managers think stocks are necessarily overvalued and awaiting a fall.
When markets are leveraged and fear is in the driver's seat, you get a situation where selling begets selling, fear begets fear, and stocks just can't seem to find a bottom. That's exactly where we are today.
Credit, credit, credit
If there is one bit of justification to the recent swoon, it's that credit markets have all but ceased to exist. If credit markets stay choked up for a long time, it's nearly impossible to predict a company's future earnings, and if you can't predict their earnings, markets turn into a multitrillion-dollar guessing game.
Regardless, the important thing to know is that the levels stocks are trading at have become completely detached from the fundamentals that drive their long-term value. Sure, credit markets are in the tank, but that will eventually subside, we just don't know when.
If you think the world will still be around in five years, there's a good chance you'll look back at times like today as a once-in-a-lifetime buying opportunity. That's not to say stocks won't continue their cliff-dive from here, but long term, there's little explanation for why the Dow is trading where it was over a decade ago.
Relax. Take a deep breath. We'll make it through this mess, Fools.
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