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Panic flashback

Whew! What a wild wide today on Wall Street — apparently driven by concerns that a debt-driven contagion could take hold in Europe and spread around the world. The Dow Jones Industrial Average was down almost 1,000 points (9.2%) before recovering to a 348-point loss (3.2%).

Here's a gut-wrenching summary from the Wall Street Journal:

Stocks plummeted in a flashback to the panicked trading of 2008 as investors registered deep fears about the European debt crisis. Selling accelerated late in the day due to a wave of automated sell orders that turned an ugly drop into full-blown market washout.... The velocity of the plunge in stocks was breath-taking.

Fears of contagion from Greece's debt crisis grew during the day and stocks were lower for most of the session. But many were at a loss to explain why stocks suddenly made such a staggering move.

A near 1,000-point drop is "people jumping out of windows" territory, said Gerard Cassidy, an analyst with RBC Capital Markets.

As losses piled up, the Dow went into freefall, tumbling through 10000, before dropping as much as 998 points, or 9.2%. The biggest closing point drop in the Dow's history occured on Sept. 29, 2008, at the height of the financial crisis, when the Dow ended the day down 777.68 points, or 6.98 percent.

One observer suggested to the WSJ that photos and video of street protests in Greece played a significant role in today's market turmoil.

"To tell you the truth, people are seeing what's going on in Athens on CNBC and it's not helping the market at all," [said Joe Benanti, managing director at Rosenblatt Securities]. "You're just watching things sort of melt away."

As much as anything, this could simply be an overreaction on the part of extremely jumpy investors, following a year of huge market gains without any significant corrections. The Greece situation and potential it seems to have to spread and roil the debt markets just looks too familiar to what happened 18 months ago. Sometimes when the market has run up too far, too fast, just about anything will do as an excuse for a fall (though they aren't usually as dramatic as today).

There's another key ingredient here: fear. The old saying is that the stock market "climbs a wall of worry." Worry is out there all the time, as investor fret about this and that. But some days that worry, given the right spark, explodes into full-blown fear. The WSJ's MarketBeat blog reports the market's "fear index" (also known as the VIX) is "currently hovering around 40, a level we haven’t seen since April last year."

It's difficult to know precisely what to make of this. Most fears are unfounded — as noted in our our February 2008 cover story, The High Cost of Fear (subscriber link). Or at least things we're fearful of don't turn out nearly as bad as first assumed.

But, on the other hand, sometimes fear can help protect us from genuine threats. And, make no mistake, genuine threats are out there, as we have noted many times here on the blog and in our monthly newsletter.

The best approach is to review your long-term plan, reflect as calmly as possible on current events, and keep away from emotional decision making.

As noted in our January 2009 cover story, How to Avoid Panic and Reduce Fear (subscriber link), "[i]nvestors are biologically induced into short-term thinking by the stress hormones released during episodes of acute fear. Fear has the effect of inducing concrete short-term thinking with poor flexibility in judgment."

Remember our SMI bedrock verse: "For God has not given us the spirit of fear, but of...a sound mind" (2 Timothy 1:7).

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