Let the panic begin…
The Dow Jones index fell 666 points on Friday. Which seems like a massive fall if you’ve been around for a while. But with the Dow coming off all-time highs over 26,000 points, it doesn’t represent the crash that it would have a few years ago.
Still, a 2.5% one day fall is pretty decent. The Dow is now 4.2% off its high from last week. Which is nothing really, but given the next biggest decline was a 6% fall between April and June way back in 2016, then it’s going to get some headlines.
This correction has been brewing for a while. All it needed was a catalyst. And that came on Friday in the form of better than expected employment and wage growth numbers in the US.
It’s all pretty standard, I might add. US stocks went up a lot over the past few years. They ‘should’ now come back a bit. How much?
At the end of last year, I told subscribers of my advisory service, Crisis & Opportunity, that a correction of up to 20% should not come as a surprise in 2018.
Whether that will happen or not is another issue. What the market ‘should’ do and what it actually does are two different things.
All I can say is that if a decent correction plays out over the next month or so, it will be healthy for the market. But if the correction is short and sharp, and stocks rally to new highs on even greater optimism, then I would be more concerned about a destabilising ‘crash’ scenario unfolding later in the year.
The pace of recent gains has just been too quick. It’s unsustainable. Unfortunately, such quick and easy gains give many investors an unrealistic view of how markets work. This is what changes the psychology of markets and sees money pour into stocks, pushing them higher.
Easy come, easy go
This is exactly what happened in crypto markets at the end of last year. Quick and easy gains saw an influx of money hoping for more quick and easy gains.
This is how bubbles form. Bubbles are a result of belief. Busts are a result of disbelief.
In that case, Bitcoin is going through a disbelief phase. The recent price action has been decidedly bearish. It’s down 60% from the highs and plunged through the 200-day moving average (the red line in the chart below) last week.
[Click to enlarge]
This just goes to show why it’s so difficult to make money in a bubble.
To get in early, you must be a believer. In this case, you must believe that Bitcoin and the technology that underpins it make it a worthy digital currency and that it will become the future of money.
When the price rises and confirms the views of the early believers, they have this belief reinforced. They are so invested, both financially and emotionally, they don’t see the blow off phase for what is it.
That is, a greed-based price surge. It’s not a result of thousands of people agreeing with the early believers. It’s the result of thousands of people trying to get rich quick, and not giving a hoot about the reasons why.
Because the early believers are so committed, they can’t sell. They don’t want to. Which is fair enough. But they no longer control the price. Once the price turns, the whole psychology of the market turns. The late-coming speculator panics. They got in too late and are now underwater. They just want out.
And the early believers see their fiat currency based gains evaporate. (Which, by the way, apparently doesn’t matter when it comes to bitcoin — although I’m not convinced about that.)
This is how you get to the other side of a bubble. It deflates just as fast as it inflated. Which means in the next six months, bitcoin will probably head back towards US$1,000.
Then, if it remains stable for a prolonged period of time, it may have a chance of becoming what its supporters hope for — a digital currency that will give inferior fiat currencies a run for their money.
A good currency is a stable currency. With bitcoin soaring, and now plunging, on a daily basis, it doesn’t fit the requirements of a ‘good’ currency.
But hopefully now, with the euphoria phase over, it’s on the path to becoming one…
Editor, Crisis & Opportunity