The Stock Market Is Looking Really Bad: Four Theories on Why [Updated]

The Dow dropped more than 500 points today, one of the biggest drops since those dark days when two-dollar bills were getting scotch-taped on the doors of defunct investment banks. There were similar drops for the S&P 500 and NASDAQ, while investors shifted money into gold (up 1 percent) and cash. One tiny silver lining: shaken investors haven’t lost their appetite for U.S. Treasury bonds, assuaging fears that they would become less solid in the wake of the debt stalemate.

So much cash has been deposited into the Bank of New York that the bank will begin charging some cash accounts a 0.13 percent fee — a negative interest rate, in other words, seldom seen outside of Japan. The S&P is now officially in “correction” mode — that is, it’s dropped more than 10 percent since its April high — and the markets have effectively erased all the gains to date in 2011. And they say you can’t reverse the effects of aging!

So what caused the drop? Even if Felix Salmon writes, rather Zen-ly for a finance blogger, that “[I]t’s worth remembering, on days like this, that sometimes we don’t know why markets have moved, and sometimes there simply is no reason,” almost no one else has laid off the speculation. We’ll get in the game, too:

Theory 1) Wall Street doesn’t like the debt deal. The market didn’t actually dip all that much when it appeared Congress might let the debt-ceiling deadline pass without taking action, but as soon as news of the specific terms of the deal hit, that’s when the market started tanking. The worry is the U.S. is headed for the dreaded “double-dip” recession, since the debt deal reduces federal spending just when the economy needs cash pumped into it most.

Theory 2) This has been coming for a while, given the general slowdown of the world economy, and the massive uncertainty over what will happen with the European debt crisis. Maybe the debt deal and worry over the U.S. compounded things, but it didn’t singlehandedly create or even trigger the problem.

Theory 3) Stocks are still overpriced relative to earnings, and today’s drop was a dramatic step along the way toward an inevitable return to sea level. The S&P’s stock-price/earnings ratio is still slightly above the average over the last 50 years, David Leonhardt points out, and expensive stocks are but “one more reason to be concerned about the economy.”

Theory 4) The Smurfs are to blame. Ever since Papa Smurf rang the opening NYSE bell on July 29, the Dow Jones Index has lost more than 1,000 points. Where’s Gargamel when you need him?

Stocks Dive on Fears of Global Slowdown [NYT]

The Stock Market Is Looking Really Bad: Four Theories on Why [Updated]