Small investors can only shake their heads as this week draws to a close on Wall Street. The stock market has been what some analysts have called bipolar.
Monday's over-600-point drop in the Dow Jones Industrial Average was followed Tuesday by a more-than-400-point rebound. What happened in that two-day span? Not a lot, really.
Monday's huge sell-off was motivated, in large part, by Standard & Poor's downgrade of U.S. debt from AAA to AA+. By Tuesday morning, many investors had decided they had overreacted and the market snapped back.
Then Wednesday, the market sank again – this time over fears that European banks are teetering on the brink of default. But Thursday brought some mildly encouraging economic news, and stocks roared back Today, the Dow was up again by triple digits at midday.
William Schulze, professor of Applied Economics and Public Policy at Cornell University, says investors can be excused if they are more than a little confused.
“Simply put, Monday’s stock market sell-off was a gut reaction based on fear, and Tuesday’s rebound was based on the realization that S&P is without a doubt incompetent,” Schulze said. “What they did in downgrading the U.S. credit rating was the equivalent of yelling ‘fire’ in a crowded theater, setting off a panic when, in fact, they knew there was no fire.”
Schulze is especially critical of S&P, which alone among the ratings agencies took the U.S. credit rating down a notch. And, he says, their recent track record hasn't exactly been impressive.
“S&P, along with the other rating agencies, has been under investigation by Congress for giving AAA ratings to toxic mortgages that led to the 2008 financial crisis and Great Recession,” Schulze said. “In addition, S&P gave Enron high ratings on the day that it failed, and gave an A rating to Lehman Brothers just before it failed. S&P also missed Ireland, Iceland, Spain and Greece.
For small investors, being a spectator to all of this might be the prudent course of action. At least, you should be able to sleep better at night.
“The stock market will be unstable for some time, until people are reassured that the time for fear is over,” Schulze said.