Stop trying to make sense of the stock market.
The one question every investor was asking on Monday has no answer: Why? Why did the Dow Jones Industrial Average close down nearly 1,200 points, or 4.6%?
Market commentators are already arguing that stocks were bound to fall because interest rates are rising and inflation is sure to jump as the economy heats up. But a week or two ago, before stocks stumbled, analysts were saying just as glibly that moderate increases in interest rates and inflation were good for stocks.
Yes, stocks have been expensive by historical measures for some time now. And investors have been extraordinarily optimistic. In January, near-term earnings estimates for the companies in the S&P 500 rose by the largest percentage since 2002, according to FactSet.
What’s more, the abnormal smoothness of the stock market over the past couple of years set investors up for a shock whenever stocks did fall at least 5%, as they did on Monday. As I pointed out last month, in the low-volatility market we’ve seen until recently, “even slight declines are apt to set off talk of Armageddon, and you will need to focus harder than ever on long-term returns to keep short-term losses from rattling you.”
That’s because the pain of a market drop depends not merely on its size, but on its steepness relative to recent experience. A 5% drop back in late 2008 or early 2009 was almost routine; now it feels like a frightening deviation.
Bear in mind, too, that some index funds—those autopilot portfolios that seek to match the market by holding all the stocks in a benchmark—tend to execute their trading orders around the close of trading at 4 p.m. Eastern time. That can reduce a key source of buying during the middle of the trading day.
But just as no one knows, to this day, why the stock market crashed in September 1929 or October 1987, searches for a rational explanation of Monday’s madness are futile.
The novelist Joseph Conrad understood human nature. In his memoir, “A Personal Record,” published in 1912, he recounted a chilling story from his family’s history in Poland.
After a troop of Cossacks invaded the grounds of the home of Conrad’s wealthy grand uncle, dozens of peasants surged in and around the house. A loyal servant and a local priest placated the crowd, and the tension began to dissipate.
Then, as much of the crowd started to head home, one of the peasants stepped to the window. He bumped into a dainty table; as it hit the floor, coins clinked inside it. He bashed it open, and gold coins spilled out.
Instantly, the crowd shifted from retreat to rampage. They swarmed inside and “smashed everything in the house, ripping with knives, splitting with hatchets, so that, as the servant said, there were no two pieces of wood holding together left in the whole house.”
That’s what markets are like. Tens of millions of people don’t always act rationally in response to new information; often, they react to nothing but how they think other people are acting or will act. Logic can melt into emotion in the blink of an eye.
Monday’s madness is a reminder that investing in stocks doesn’t automatically make people rich. Twice in the past 20 years—between 2000 and 2002, and again between 2007 and 2009—the stock market has cut investors’ wealth roughly in half.
No one can say when that will happen again, but everyone should know that it can—and very well might. If a 6% daily drop makes you squirm, then you probably have too much invested in stocks for your own psychological good.
Write to Jason Zweig at firstname.lastname@example.org, and follow him on Twitter at @jasonzweigwsj.