An investment market plunge like this hasn't been experienced since World War II according to CNBC. With the market on cusp of a 20% drop and no end in sight, the state of the world markets is far more than something we read about in the news. We're finding ourselves at a point where all of us could feel the acute effects just as we did in 2008 and 2009. Still, market contractions such as this produce both winners and losers. Here are a few of the representatives on each side. (For more abou the crash, check out The Fall Of The Market In The Fall Of 2008.)
TUTORIAL: Economics Basics
The Retail Investor
From July 22, 2011 to August 8, 2011, the S&P 500 dropped 17%. Although the professional stock traders like hedge fund and mutual fund managers have felt the pain, the retail investor may get hit even harder. For those with little market knowledge and a 401(K) or other retirement vehicle, moving money out of the market to avoid catastrophic losses is very difficult.
For those who actively invest in stocks, ETFs, and other more liquid investments, research indicates that retail investors may not have the experience and information needed to protect their money. According to a research study conducted by Barclays, retail investors often mistime market direction. If history is any guide, stock market plunges such as this one will cause the retail investor to get out of the market too late and sell too early once the recovery begins because retail investors tend to react to movement instead of being proactive.
How can the average investor become a winner instead of a loser? Have a long term perspective on the market. Although the move has been massive and scary, better times may be on the way. Historically, after a move of this magnitude, one month later the S&P 500 saw an average gain of 4%. Three months after a big downward move, the S&P 500 has seen an average gain of nearly 7% and a gain of 9% over the next six months. Those who don't panic and stay patient will see big gains over time.
The Obama Administration
The research isn't clear. One academic study found that, when the stock market falls, so does a president's approval rating. In contrast, Bespoke, a popular investment market research service found an inverse relationship. When the stock market goes up, a president's approval rating goes down. Although the research isn't clear, it's clear that a crash in the U.S. investment markets is another piece of bad news that the Obama Administration doesn't need moving in to an election season. Presidential candidate Mitt Romney blamed the recent downgrade of U.S. debt on a "failure of leadership."
Not only do two thirds of polled Americans believe that the economy is going in the wrong direction, a large majority of respondents disapprove of Obama's handling of the economy. At the end of July, before the stock market plunge, his approval rating was only 42%. Karlyn Bowman, a public opinion analyst, had sharp words for Obama, "It's a performance-based job, and people want to start seeing the economy turn around."
In politics, every opinion has an opinion to the contrary and, although many people approve of the Obama Administration's handling of the economy, few would disagree that negative economic news not good for a sitting president.
It was only a few weeks ago that the price of oil was hovering around $100 per barrel and many oil traders believed that prices would go higher. Now, with oil down nearly $15 and heading towards a 20% decline, traders are scrambling to position themselves for what many believe will be an economy with the brakes on. This may keep the price of oil at uncharacteristically low levels for a while. (For past causes of market decreases, read What Caused The Flash Crash?)
On August 8, when the S&P 500 lost 6.66%, the price of gold was up nearly 4%. As investors become more fearful of the world economy and investment markets continue to weaken, gold is the safe haven of choice for many. Already up 21% in 2011, some strategists believe that in just a few weeks, gold may rise to the $2,000 level.
How can you become a winner in the gold market? Buying physical gold is often not practical for the retail investor, but buying an exchange traded fund that gains value as the price of gold appreciates is a practical solution. Noted stock market expert Jim Cramer recommends the SPDR Gold Trust (NYSE:GLD) as the best way for the retail investor to make money in the gold market.
Short sellers are investment market traders who purchase investment vehicles that rise in value when the investment market falls. A stock market that is down 17% means big profits for short sellers.
Short sellers may not be winners for long, though. When markets drop violently, short sellers often take center stage. Greece has banned short sellers. With the one day drop of 20% in Bank of America on August 8, short sellers are being blamed for that as well.
How can you use short selling to become a winner? Although many retail investors short sell, it is only recommended for the advanced trader. For most retail investors, short selling isn't a money making strategy.
Italy and Spain
Spanish and Italian bond rates have been rising and rates have recently lifted borrowing costs to unsustainable levels for these countries. This was attracting short sellers who were threatening to further push borrowing costs higher, making the threat of default a real possibility. In part because of the global market turmoil, the European Central Bank faced more pressure to intervene and it did. The bank made massive purchases of Italian and Spanish bonds, pushing interest rates lower and sending short sellers the message that the ECB will continue to buy to keep borrowing rates at a sustainable level for these countries. Short sellers don't want to fight the European Central Bank, so the financial dogs have been called off for now.
The Bottom Line
In reality, when global markets plunge and real people are affected, there are no winners. The bads clearly overshadow the goods. The best thing that can come from an event such as this is to learn from it and be prepared the next time it happens - and not just in terms of retail investors, but also governments and major players in the investment markets. (To help you pick winner, see How To Make A Winning Long-Term Stock Pick.)