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Crashes, corrections, recessions and more. Can you define the market terms we hear everyday?

If you’ve ever felt like you need an investment dictionary or acronym glossary to decipher the financial news, watch as Jonathan Scheid explains the basics of stock market vocabulary.

Transcript

Tim Maurer:
Tim Maurer back with another episode of Ask Buckingham, a new video podcast designed to bring clarity in the midst of confusion by connecting your great personal finance questions with straightforward answers from industry thought leaders. Today’s question will be answered by Jonathan Scheid, Buckingham’s managing director of solutions. Jonathan, I want to talk about market terminology. Especially these days but really on just about any day in the market, the financial media comes up with market crashes and surges and everything is hyperbolized, but indeed we have had some pretty crazy occurrences in terms of big historic up and down days. Would you mind bringing us up to speed on some of this terminology? There’s a market crash, a correction, a pullback, a bull market, a bear market. Do any of these things actually officially mean anything?

Jonathan Scheid:
They actually absolutely do. Every industry has its jargon, and ours is just a little more mainstream, right, because we hear it on a lot of the market news channels and it makes it into the daily radio broadcast that we hear just as we hear little snippets of what’s being summarized in the marketplace. I think that’s where a lot of these terms have come from, is there are ways to help everybody understand either the depth of a decline or potentially what’s happening in the increase in the market.

Jonathan Scheid:
A crash, that’s just a fancy name for markets are falling quickly. It’s like an auto wreck, a crash, boom. Things, they hit and they’re hitting hard and they’re hitting fast.

Tim Maurer:
Okay.

Jonathan Scheid:
A correction is typically referred to when there is a 10% decline in prices from a recent high.

Tim Maurer:
Okay.

Jonathan Scheid:
That actually occurs, believe it or not, about once a year. We see that pretty commonly throughout time. That’s the average. It’s not required to happen every year, but it can happen as frequently as every year, and sometimes you’ll get multiple 10% corrections. I’m not a huge fan of the word correction, just because it implies that prices were not correct before and now just a 10% decline corrects them. I think that’s an oversimplification, but generally the term is associated with just a 10% decline in market prices.

Tim Maurer:
Okay.

Jonathan Scheid:
A pullback is just a nice way of saying or a different way of saying that markets have declined, so they pulled back from their highs.

Jonathan Scheid:
A bull and a bear market, you’re going to hear these all the time as people like to classify the direction that stocks are going. A bull market is usually associated when prices are moving up. A bear market is associated when prices are moving down.

Tim Maurer:
Okay.

Jonathan Scheid:
Are you familiar with why we use the term bull and bear market? Have you heard of the history here?

Tim Maurer:
I’m sure I learned it at some point in time, Jonathan, in my finance degree, but remind me.

Jonathan Scheid:
Yeah. I think it’s playful here. A bull market gets its meaning from how bulls attack. If you ever think about a bull attacking, it typically crouches down and then with its horns, it moves up, and so that’s the direction that prices are moving in a bull market. Bulls attack up, and so that’s where we get this idea that prices move up.

Jonathan Scheid:
From a bear market standpoint, bears typically take their massive paw and their claws and they strike down, and so that’s the parallel to why we have declining markets. Similar to how a correction had a number associated with it, so we have to see a 10% decline to get a correction, bear markets are usually after markets have fallen about 20%, so it doubles what the correction decline was and that’s off of a recent high.

Tim Maurer:
Okay. Any specific number associated with the bull market?

Jonathan Scheid:
It depends. Some people will want to see another 20% on that side, so they want to see prices rise 20%, otherwise … What will happen is markets will fall. They’re 20%. They’ll say, “Okay, we’ve triggered this bear market.” They might go up for a little bit. They might go down and move around in a sideways fashion. Once markets do recover 20% off of that low, that’s typically where the bull market is going to come back in. It’s really interesting. We’re talking jargon here. There’s a saying that I always like to use, and that’s markets take the stairs up and the elevator down.

Tim Maurer:
Aha.

Jonathan Scheid:
If you think about you’re going to hear markets being in a bull market the majority of the time because then when these bear markets happen, that’s when that elevator example comes in. They come down and they come down pretty quickly. If you look at any historical market pattern, you see this period where they go up and then they go down very quick; and then they gradually go up, they’re taking those stairs up, and then they take the elevator down.

Tim Maurer:
Personally, I prefer that illustration because I’d rather not be attacked by either of these large and powerful animals, but now let’s talk about if you’re focusing in a little bit more closely on some of the jargon that you might see especially in the financial media or on an app that you have. You might have heard something about a halt in trading recently or futures being limit down. Could you bring us up to speed on these terms?

Jonathan Scheid:
Absolutely. These are more technical terms. The name that we would use for a halt in trading is referred to as a circuit breaker, so you might also hear that. When there’s panic selling, and this actually was instituted by the exchanges following, it was a Black Monday crash in 1987, so following that environment where markets were down, I want to say 22%, they instituted these circuit breakers to slow down traders and to let them gather their breath and get some perspective on the new news that might be making them hit the sell button faster than they were in the past.

Jonathan Scheid:
There’s actually three circuit breakers on the US Stock Exchange. One gets triggered when you have the same day decline of 7%. Another gets triggered at 13%. Then, a final one gets triggered at 20%. When you hit a 7% threshold, we pause trading for 15 minutes, let everybody catch their breath, reassess the news. Same thing happens at the 13% level. If we make it to 20%, they say, “You know what? Take the day off. Go home early. We’re going to digest this over the evening.” They shut down trading for the day once you hit that 20% level.

Tim Maurer:
Have we seen anything historically since 1987 with these measures instituted where you could actually see how it does change, how a crash might take place?

Jonathan Scheid:
Yeah. I think it was triggered in the late ’90s. We saw it in the global financial crisis, but just more recently, in March of 2020, during this coronavirus contraction, I think we’ve seen it triggered already five times as of the recording of this video. It actually has helped. I know earlier on in the trading when we had the 7% trigger put into place, the 15 minutes actually did help to stabilize the market. It didn’t reverse direction, but it didn’t decline further once that got triggered. They seem to be fairly effective, even though they’re rarely used, and that’s a good thing.

Tim Maurer:
Interesting. I can remember from my days back on the trading floor that the market is open from 9:30 to 4:00 PM Eastern Time. Did I get that right?

Jonathan Scheid:
That sounds about right. Yes.

Tim Maurer:
Okay, but then if you wake up earlier than that and you take a glance at the financial news, you might see something about futures being up or down. What are they referring to?

Jonathan Scheid:
There’s a way that you can make an investment outside of market hours, and those are referred to as the future market. They have different hours in the US. They’re not open 24 hours in the US. There are ways that you can trade them around the globe, but maybe that’s a different video. Future markets are just ways that you can bet on indexes on going up or down and getting some exposure to those. If a major news story happens outside of a market hour and you want to trade on it, futures give you the way to do that. They have their own circuit breakers. You mentioned limit down as one of those. A limit down is the same idea as a circuit breaker that we were just talking about for market trading. I think it describes what it’s trying to do. It’s trying to limit the downside.

Jonathan Scheid:
For US stock indexes, it’s commonly a 5% change. Believe it or not, there’s a limit up as well. You can limit the downside to just 5%, and you can also limit the upside to 5%. Believe it or not, over this last trading cycle, we’ve seen limit downs and limit ups used in both cases because they don’t want panic at the open, and I think that’s part of the reason why you have these lower thresholds versus what is in the market at the 7% versus the 5% on the futures.

Tim Maurer:
Fascinating times for sure. Lastly, Jonathan, what about recession and depression? Are we in a recession right now? The word depression has already been thrown around in some of our worst days. Are these market terms or economic terms?

Jonathan Scheid:
They are economic terms and markets react to them. Markets react because we’re investing in companies, in those stocks and those bonds from the different companies. When we see the economy start to struggle, that means that the profits and revenues associated that these companies are earning might go down. Since valuations are derived from those earnings, stock prices adjust. Most market declines, bear markets have been associated with recessions or coming recessions, and so I think you’re seeing that concern right now being voiced in the market.

Jonathan Scheid:
The term recession is loosely defined as two consecutive quarters of negative gross domestic product so your economy is not growing. It’s actually declining for two quarters. That’s what the industry uses as a term. An actual recession is defined by a government entity known as the National Bureau of Economic Research, NBER is their acronym, and they look at monthly data and so they’re looking to see the peaks and valleys of economic activity. They’ll be more specific in what they define as a recession, but they always define it after the case and so you never know when you’re in a recession.

Jonathan Scheid:
We don’t know right now if we are in a recession. It’s probably pretty likely that the second quarter of 2020 is going to be a negative quarter just because of the number of people that are sheltering in place and the business that isn’t taking place. When you think about the restaurants, hotels, airlines and then the fall in oil prices, there’s going to be an impact, but that’s, that’s already been priced in. That’s the beauty of markets, is that they react very quickly and they price this concern in, and that’s why we see this bear market right now.

Jonathan Scheid:
Depression, just to get your last term there, that’s going to be a more severe version of a recession. Both describe a fall in economic activity. A depression is just going to be a longer, more sustained fall in GDP growth, that is. The US, we had our Great Depression. That was a multi-year event where the economy had a really challenging time moving along. I would say it’s probably very challenging just given where medicine is right now and the fact that this is not an economic or a financial-related or induced [crosstalk] recession that we’re likely going to be in. It’s more from this sheltering in place and the fact that everybody has shifted their buying behaviors for a period of time.

Jonathan Scheid:
Once everything settles down, we would expect things to return to somewhat more normal. I think it’d be really challenging to say that the odds are high for a depression, whereas a recession, we’re likely going to see … I’ll say it’s probably almost a given that Q2 is going to be negative, but how long does it continue, that’s yet to be seen.

Tim Maurer:
Yeah. Is it true that the last time we actually suffered a depression in the United States was the Great Depression?

Jonathan Scheid:
That’s correct. Yeah. We did struggle. The economy did struggle in 2008 and 2009, but it wasn’t for a long time period. If you think about it, markets and the economy peaked in 2007 and then things were already looking better midway through 2009.

Tim Maurer:
Well, Jonathan, I really wish we had this conversation before my first Finance 101 exam at Towson University in 1995. It really would’ve come in handy. Now that we’re just thinking about it from the perspective of an investor, what if any application is there to these terms? Are we just educating ourselves here or would you recommend investors actually act when they hear these buzz phrases?

Jonathan Scheid:
Yeah. We think it’s more about communication and education when this terminology is used. It’s easy to say, “Hey, the markets just experienced a correction,” versus saying, “Oh, the markets are down 10%.” I think people probably prefer to use words more than numbers, and I think that’s where we get these terminologies just because people can understand them and interpret them a little better. Taking action on them, we don’t think that makes a lot of sense. Stick to your plan and just focus on how your portfolio is diversified and focus on what you can control.

Tim Maurer:
What we can control indeed. That is such a big factor these days. I think that it’s that lack of control that makes all of us feel like we want to go do something, but indeed, oftentimes, those steps might not be in our best interest. Well, thank you for the education, Jonathan, and thank you for tuning into this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, askbuckingham.com, or emailing your question to question@askbuckingham.com, or just click in one of the corners of the screen, it’ll take you directly to the website. Remember that there are no dumb questions, so don’t worry about that, but unfortunately there are plenty of poor answers out there. Our hope is that in giving you straight answers to your questions, it will bring a sense of calm and allow you to apply what you’ve learned in pursuit of good decision-making. Please, follow us, and by all means, Ask Buckingham.

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