What is a ‘Sell-Off’?
A Sell-off is the quick selling of stocks, indices and commodities on a global scale. On a microeconomic level a sell-off may occur for many reasons, including disappointing data. On a macroeconomic level, a sell-off in the broader market may occur when there is political instability or global turbulence.
Sell-Offs Are Only Natural
It is important to understand that a sell-off, even one of a global scale is a natural occurrence that can be triggered by something as simple as profit-taking or short-selling. In fact, all healthy price uptrends require periodic sell-offs to replenish supply and trigger demand. These types of “minor” sell-offs are also called pullbacks.
An extensive sell-off can signal a potentially dangerous market reversal and trigger a bear market. Bear markets are defined by two distinguishing characteristics. The sell-off must remain at least 20% from the highs for a duration of at least two months. The most recent bear market sell-off occurred during the housing bubble and global financial meltdown of 2007-2009 when the S&P 500 dropped 57%.
What Could Trigger The Next Bear Market?
As long as we have an interconnected global financial system, we will have financial crises, there’s no avoiding them. A bear market however, can be triggered by a number of factors, some more evident than others. Obviously back in 2007 the global recession caused by the housing and credit bubble had an adverse effect on the financial markets. But there are of course many other factors that could cause a bear market:
- Serious policy mistakes like excessive national debt in leading economies such as the U.S. can lead to a self-inflicted financial crisis
- Low rates are a double-edged sword. Interest rates have been declining since 1980, and they have remained low until recently.This can create high levels of systemic risk in the financial system and leave many financial and corporate institutions more vulnerable to rises in interest rates. This could in turn lead to another credit bubble.
- An E.U. collapse: The Eurozone has adopted a common currency for its members encouraging the flow of capital into countries like Greece, Portugal, Italy and Spain that previously had a hard time attracting investors. However when the last crisis hit, investors pulled their money from these countries, causing major stress to their economies. Ever since, there has been a threat of a breakup of the Eurozone which was further fueled by Britain’s decision to leave the union. An E.U. breakup would mean the eclipse of the euro and would of course lead to global financial instability.
- A cybersecurity Incident
A successful cyber attack against some of the world’s greatest financial institutions would lead to the loss of funds and possibly the ability of banks to function properly. This can in turn cause major panic and disruption in the entire financial system.
*Sources: Investopedia, Seeking Alpha