What Really Caused Monday's Dow Selloff?
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This is Your Money Matters from The Wall Street Journal. Welcome to Your Money Matters. I'm J.R. Whalen in New York.
What triggered the Dow's 1,100‑point selloff on Monday?
So what was behind Monday's record 1,100-point sell-off for the Dow Jones Industrial Average? Wall Street Journal reporter John Cendrillo joins us to help dissect the steep decline and the lingering volatility. So, John, we've heard that inflation fears and rising bond yields certainly played a part. But in your story in the Wall Street Journal, you mentioned it also had a lot to do with too much calm among investors.
Yes, it's one of those. There was this famous American economist called Hyman Minsky who once said that stability brings forth its own instability. It sort of breeds under the surface. And it can happen in financial markets as well. And a lot of investors that we talked to seemed to believe this is what happened. They were saying, well, surely there was a bit of a fear that higher bond yields mean that stocks are not as attractive. But actually, if we are not, you know, we're still very bullish about the economy. We're still think things are going well. So we cannot make sense of what's going on in the stock market if it's not because of all the people who are sort of trading a series of products that are linked to volatility, volatility being how much the stock market goes up and down.
And there's like a range of investors in the market that are betting on whether volatility will be high or volatility will be low. And because the stock market has been so calm for the last two years, we found that a lot of investors were trying to squeeze some extra return by betting that it would stay calm. And what happens if you do that is that when suddenly it doesn't stay calm for whatever reason, suddenly you lose a lot of money and then you need to offset all those bets that you made that are now losing bets. And it's sort of a reinforcing feedback loop. And this is a bit what we've seen over the last couple of days. And It's interesting because we actually wrote about this before it happened, that it was a possible concern.
It was interesting to actually see it unwind.
And investors are placing bets on volatility on something called the VIX. It's a ticker symbol VIX, and it's the CBOE Volatility Index. And like you said, they have become very complacent. And for about two years now, we have seen not a lot of volatility. We've seen a lot of upward trajectory in the markets.
How did investor complacency and a long period of low volatility contribute to the crash?
And I guess that they took their eye off the fact that you know, gravity eventually is going to take hold at some points.
In the end, it is a bit like, so the VIX is basically, it's not a product in itself. You can trade it through different kinds of products and several of them have had issues in these last couple of days. It's more like they look at derivatives that are built around these stocks and then they sort of, you know, they extrapolate like a price on whether investors believe that stocks are likely to swing higher a lot or not in the near future. But in the end, it works a bit like I like to compare it to hurricane insurance. There are some people selling insurance. There are some people buying insurance. Over the long term, you kind of know that the people who sell insurance tend to win because you don't really insure your house against tornadoes because you want to make money.
You do it to be able to sleep at night. So in the market, it's a bit the same. So in theory, betting against this volatility is a good long-term strategy. And betting for volatility is a bad long-term strategy. But what ends up happening is that if you act like an insurer, you'd better be ready for it. And ready means that, well, there comes a day where there is an actual hurricane or a tornado, and then you've got to pay out and you need to be able to do it. And this is where a lot of these products and a lot of the investors investing in them get a bit complacent. And they might find that they don't have the liquidity to pay, and then they have to offset those bets somewhere else and they end up hurting the broader market.
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