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The August stock slide, explained

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On Friday, August 21, American stock markets had a really bad day with the broad S&P 500 index (roughly the 500 biggest companies listed on US stock markets) losing well over 3 percent of its value — a plunge that was followed by further declines over the weekend and on Monday morning.

The fall, though certainly large, was by no means catastrophic by historical standards. But it is having an outsize psychological impact on stock owners because it comes in the context of what's been an overall very "meh" 2015 for stocks. And it was followed by derivatives trading on Sunday night and Monday morning that indicates further declines are in store.

Both the real economy and the stock market crashed from the fall of 2007 all the way through to the spring of 2009. But while economic growth since that time has been generally disappointing, the stock market has soared.

In 2015, though, that pattern has broken down.

The economy continues to add jobs at a slow but steady pace, but the S&P index started the year at 2,058 on January 2 and was at 2,060 as of early Thursday morning — dead in the water. In that context, the sudden decline on Friday feels to many like a bad portent, a clear signal that a years-long bull market is over and now the bears are running the show.

It's a huge deal for investment professionals, and a sustained downturn could be very bad for people near retirement. But it's always worth keeping in mind that most people don't have much to fear from a stock market decline — even a severe one.

1) Bad news from China supposedly caused the crash

The truth is that nobody has any idea what causes short-term stock market fluctuations. And to the extent that anyone even thinks they have a way of finding out, they're not going to tell you about it or blab to the press — they're going to trade and make money.

But broadly speaking the key source of negative sentiment seems to be a run of bad economic news out of China. This has been a story all summer, but the declining price of Chinese currency since mid-August has made it clear that there are real international implications.

You can see the central role of China-related fears in the extraordinarily poor performance of companies like Apple (down more than 6 percent) that have relied on Chinese customers to fuel much of their recent growth. The China effect is also visible in the price of a wide range of raw materials, all of which are falling in anticipation of weaker Asian demand.

None of this really explains why Friday in particular was so bad (Chinese growth was also slowing on Wednesday), but it's what traders are thinking about.

2) The stock market's had a great run

Since bottoming out in the spring of 2009, US stock markets have enjoyed an excellent run. There have been some hiccups in the years-long bull market, especially centered on America's sporadic political crises, but mostly it's been an era of up, up, and away for American stocks.

In part, this is because the economy has grown steadily this whole time.

But overall economic growth has still been much less impressive than stock market performance. The excess performance of stocks has been driven by a few factors:

  • With wage growth slow, the corporate profit share of overall national income has risen, partially offsetting overall national income's slow growth.
  • Many big US-based companies have plenty of foreign customers, and have benefited from stronger growth in Asia even as the US economy has been weak.
  • Low interest rates have made it possible for many companies to borrow money cheaply in order to spend on share-boosting strategies like higher dividends or companies buying shares of their own stock.
  • Optimism that more robust recovery is right around the corner.

3) The stock market's had a bad 2015

In 2015, that party largely came to an end. The profit share of the economy appears to be shrinking again, as the unemployment rate is now lower and companies no longer have a limitless supply of cheap labor. At the same time, the foreign economic picture now looks very different. The Brazilian and Russian economies are both in a state of chaos, and Chinese growth is — at best — slowing down.

4) Weak stock prices might not be bad for you

If you are in your 60s, hoping to retire very soon, and have most of the money that you have managed to save tied up in the stock market, then a period of low stock prices is bad news. But while much economic commentary simply assumes that low share prices are bad, the reality is that relatively few people are actually in this situation. If you're not planning to retire for another two or three or four decades, then cheaper stocks are, if anything, a plus — it means your savings will go further as a long-term investment.

What's more, for better or worse most people just don't save that much, and the majority of stock is owned by a relatively small number of rich people.

To the extent that things like a stronger labor market and higher wages are weighing down profits and share prices, that's good for most people. To the extent that weak economic growth in Brazil and China is weighing down share prices, that's terrible for Brazilians and Chinese people but probably doesn't mean much one way or the other to you.

5) Then again, it could be a sign of something terrible

It's unlikely that declining stock prices will cause bad things in the life of the typical American. But rapid movements in financial markets are sometimes a sign of larger problems.

If American economic growth is slowing down, that's going to be bad for most Americans. And slower US growth is the kind of thing that would show up in US stock market prices — probably faster and more suddenly than it would become visible in official government economic data. Most people don't seem to think that's what's happening here, so you shouldn't get too worried. But anyone who was really 100 percent confident they could understand the ups and downs of financial markets would be getting rich, not writing about it on the internet, so it's best to admit to some uncertainty about what's really happening.

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