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Yesterday I discussed the absurdity of the stock market sell off in response to the credit downgrade of the United States by Standard & Poor’s.\u00a0 This prompted an interesting comment from the What My Intuition Tells Me Now<\/em> blog’s most loyal reader.\u00a0 Because of the depth of the thinking behind his comment I feel like it deserves a public showing, along with my response.\u00a0 My response adjusts the scale of the financial market sell off to demonstrate its absurdity.<\/span><\/p>\n Here is the comment in its entirety:<\/span><\/p>\n “Hello again Jason,<\/span><\/p>\n Forgive me if I misread your analysis, but your reasoning and conclusions appear to be based entirely on the assumption that the S&P downgrade and the market\u2019s overreaction to it were the major reasons for the selling. When calculations yield retarded answers you should first check your math then check your model assumptions.<\/span><\/p>\n I can think of a few other plausible reasons for a sell-off that have little to do with the downgrade. Some examples include: (1) continuing fears over the Eurozone crisis; (2) downward revisions made to future U.S. GDP projections (during last week); (3) perceived economic implications of the debt deal; (4) worries about the mounting law-suits against Bank of America over its handling of mortgages and foreclosures; (5) group think, general market mood, and sudden realization that the stock market was overvalued.<\/span><\/p>\n I vote for all of the above in some combination. I imagine that for many investors, a weekend was needed to digest the numerous events of last week in order to formulate a determined response. Neither today\u2019s nor Thursday\u2019s sell-offs seem like panics to me; they seem more like a return to sobriety.<\/span><\/p>\n P.S. I have noticed that the \u201cNotify me of followup comments via e-mail\u201d option does not work on this blog.”<\/span><\/p>\n Here is my response to this careful, intelligent comment, and by natural extension the heart of today’s blog post:<\/span><\/p>\n “Hi Stephen.<\/span><\/p>\n Thank you for your comment, Stephen \u2013 as always, they are appreciated, as is your loyalty to the blog.<\/span><\/p>\n Regarding the causes\/sources of the \u201csell off\u201d as described by you: I have to retort a very mild, \u201cwell duh!\u201d As you know from reading the blog as aggressively as you do, each of the factors you described as contributing to a 8 August, 2011 sell off have been talked about by me and, in most cases, for multiple years. These factors are not an oversight on my part. I wanted to highlight the absurdity of the selling yesterday relative to the only new piece of actual news: the downgrading of the U.S. government by S&P.<\/span><\/p>\n In your comment you ascribe a certain logic to the selling; implicit in this is some sort of assumption that investors are rational actors, or some variation of the \u201cefficient market hypothesis.\u201d I am basing this assertion on your numbers (1) through (4) which all ascribe some sort of logical reasons for the selling of Monday, 8 August. Frankly, I just have never experienced investors, professional, semi-professional, amateur, experienced or inexperienced as being rational, in the aggregate. So of your points the one that makes the most sense to me is \u201c(5) group think, general market mood, and sudden realization that the stock market was overvalued.\u201d Which is why I highlighted in my post the true absurdity of the selling Monday. But let\u2019s adjust the absurdity scale from the amount of additional interest expense to be paid by the United states, that I highlighted in yesterday\u2019s post, to something that should clearly illustrate for you the silliness of the magnitude of the sell off.<\/span><\/p>\n Most important in the enumeration of yesterday’s “U.S. S&P Credit Downgrade<\/a>” post is the ~$722 billion difference in equity value ascribed by investors yesterday relative to the close on 5 August, 2011. That is equivalent to a decline in market cap of approximately 5.0% of 2010 gross domestic product (GDP), or $722.735 billion\u00a0\u00f7 $14,418.16 billion. Meanwhile the total lost GDP in the Great Recession was just $353.5 billion, or peak \u201908 GDP of $14,291.5 billion \u2013 trough \u201909 GDP of $13,939.0 billion (source: U.S. Department of Commerce<\/a>). So yesterday\u2019s sell off destroyed, in wealth, double what was actually lost economic output-wise in the greatest post World War Two economic decline.<\/span><\/p>\n What\u2019s more, the cumulative plunge of the S&P 500 now stands at 17.3% dating back to the most recent peak of 7 July, 2011; or 1,119.46 (close 8-8-2011) \u00f7 1,353.22 (close of 7-7-2011). That 17.3% plunge represents a loss of market cap of ~$2,134.27 billion, or almost 7x the amount of lost economic flow in the Great Recession.<\/span><\/p>\n Regarding the \u201cNotify me of followup comments via e-mail\u201d option \u2013 I will look into it.<\/span><\/p>\n Keep your comments coming!<\/span><\/p>\n Jason”<\/span><\/p>\n I am guessing that you will agree with me that by looking at the lost wealth in the last month of financial market declines (~$2 trillion) relative to total GDP (~$14 trillion) helps to highlight the sheer madness of recent financial market selling.\u00a0 There is just no way to rationally justify the magnitude of the sell off relative to the news flow.\u00a0 Instead, in my opinion, you have to consider the irrational, as the blog commenter and I both did.<\/span><\/p>\n