How Are Sell-Offs Healthy?

Yesterday, the AP ran a story, “Market plunge seen as healthy.”

As difficult as it might be to explain to investors who lost a total of $632-billion in Tuesday’s market carnage, a correction isn’t necessarily a bad thing. It may have reacquainted investors with the concept of risk.
“Corrections like this are the financial equivalent of castor oil,” said Hans Olsen, chief investment officer at Bingham Legg Advisers in Boston. “It’s good for you, you don’t like it, but you have to take it.”

This is one of my pet peeves. People often want to make capital markets into something they’re not. They get carried away with sloppy metaphors.
For the record, markets are not at all like human beings. Going to the dentist may be very unpleasant, but ultimately good for you. Markets do not work that way. A sell-off is a sell-off. A rally is a rally. There’s no such thing as a good, or “healthy” sell-off, or a bad rally.
I have to stop and think, what exactly does a healthy sell-off mean? I honestly don’t understand the phrase. I think it’s one of those phrases people repeat often enough without considering what it means. When you say it, you sound intelligent–even a bit clinical. But is a “healthy” sell-off one that will immediately turnaround? If it is, why isn’t the market doing right now, instead of…well, selling off?
I absolutely agree that sell-offs are natural. That’s capitalism. This is what markets look like. But the healthy part I don’t get—the idea that implicit in the sell-off is reason for it not to sell-off. Does that make sense to you?
Here are quotes from the past week:
International Herald Tribune

Tuesday was a “a healthy reminder, especially to individual investors, that markets don’t go straight up,” Sonders said.

Bloomberg

“The correction was a healthy shake-out for those who had become complacent,” said Piers Hillier, head of European equities at WestLB Mellon Asset Management in London. “I don’t think we’re out of the woods.”

Even Larry Kudlow!

The plunge follows a 20% run-up that began last summer, and some analysts believe it was overdue. Indeed, 3% corrections are normal and healthy.

MarketWatch:

Large stock market declines can be a healthy cleansing for the industry. Declines purge the products, people and practices that plague the industry — those things that in a rising market suffer little or no consequence for the bad things they do.

York Dispatch:

“Frankly, it’s expected and it’s overdue,” said Crooks, a 34-year veteran of the industry. “I think it may indeed turn into a 5 to 10 percent correction (drop in price). And I think that would be very healthy.”

Reuters:

“I think risk has been underpriced in the market and frankly I’m glad to see this happening because it’s a healthy phenomenon.” said Ed Walczak, portfolio manager at Vontobel Asset Management in New York.

Posted by on March 2nd, 2007 at 3:50 pm


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