note though that the market can go down 50% and more and take several decades to recover.
Yes. Most of the time when these things happen, they involve real and significant shocks that disrupt things in a country. Economic collapses, wars, severe banking crisis, sovereign default etc. To me, these are the true risks.
But there are also the fake risks (most of the things that ZeroHedge claims should lead to a correction)
Fake risks don't affect the real variables that influence stock market performance (such as earnings, risk premium preferences, etc) they just lead to short-term bursts of people wanting to take money out of stocks.
I thought about an analogy to explain these events last year, its what I'm calling the "uber theory of the stock market".
Lets say you want to ask for an Uber in the next 30 minutes, you are not in a hurry for it, you can wait, its no big deal as you are not late for anything. Then, lets say it starts to rain. Now the game has changed, if you wait, you know everybody in the region that wants an uber, will request one, this will lead to surge pricing and lack of uber cars. All of the sudden, you not only will have to pay more, you might not get on time as the wait time for the uber to actually arrive might be much bigger than unexpected. As a result, you have to respond by asking for an uber immediatly, the faster you do it, the less problems you will face. Other people will figure that out also, but some will be faster than others. Everybody will be 'rushing' to the same door at the same time
I believe that is what causes a lot of the stock market drops with 'fake risks'. Lets say there is an a certain amount of people that are planning to sell stocks, not because they hate the market, not because there is an increase in true risks, simply because they need the liquidity. Perhaps they got a business idea and want to fund them, maybe they want a new TV, maybe a car, maybe its a hedge fund with an withdraw notice from an investor that wants to buy a TV/car/home etc.
Doesn't matter, these players need cash as opposed to stocks. But they are also not in a hurry (if they were, they would have already sold). So they are just lurking around, waiting for the best moment to sell (since stocks usually rise, waiting a bit might be a better decision then rushing the sale).
Then bad news hits (say one noisy economic data miss or some other 'fake risk' news), all of the sudden that marginal seller (that was just lurking around) might have the same realization that the guy that wanted an uber had, he needs to act now because if he waits, perhaps the market will be lower in the coming days/weeks and more players will be selling (hurting liquidity), people realize that other people will think that and all of the sudden, everybody is rushing to the same liquidity door at the same time. Yet, most if not all of the selling is irrelevant, its simply that uber effect. It doesn't mean that there is some kind of true risk going on (the market might not be 'signaling' anything), its just that the marginal players are rushing to the liquidity door at the same time because they know other people will be doing the same and all of these people are not in for the long-term with that marginal capital, they HAVE to sell soon.
Yet pundits will see the SPX down 1% because of this and that news and they think that news matters. This 'trains' them to think in terms of how markets are likely to react to news flows and things like that. This makes them not realize that stocks are a forward looking long-term investment with exponential payoffs. It takes a lot to cause a big drop in the market (and a lot of these drops are just buying opportunities), but if you are 'trained' to care about these little fake risks, you get the wrong impression about how stocks work
