Why are the markets tumbling?

Source : AP
Last Updated: Tue, Aug 09, 2011 05:38 hrs
FACTBOX - After the 'flash crash,' changes to U.S. markets

Global stock markets tumbled Monday on the first trading day since Standard & Poor's downgraded long-term US debt. The plunge came as investors grew anxious over a weakening US economy and a widening debt crisis in Europe.

Not everything went as expected. Some analysts had worried that Treasury yields would surge after S&P's downgrade. That would happen if investors demanded higher returns to compensate for their risk.

The opposite happened. US Treasury yields dropped Monday as investors sought a safe place for their cash. Their actions showed continued confidence in long-term US debt.

Here are some questions and answers about the market turmoil:

Q: Why are stock prices plunging?

A: Stocks are considered risky, especially when the economy falters. When the economy is growing, companies can expand, hire and increase profits. A string of bad economic data has led many investors to worry that the economy will dip back into recession. If that happens, stocks would likely slide further. Investors already were growing fearful about the economy before S&P's announcement Friday night. Oil prices also are falling, a sign that traders expect the weak economy to reduce demand from consumers and businesses.

Q: If everyone is selling stocks, where's that money going?

A: Anywhere safe. Traders are plowing cash into investments that are seen as hedges against economic weakness. Gold prices streaked past $1,700 for the first time Monday. And the yields on debt issued by the US Treasury fell as traders, money managers and overseas banks sought refuge from the market's wild swings. Bond yields fall as their prices rise.

Q: Why are US Treasury prices rising? Didn't S&P just indicate that they are a riskier investment?

A: Investors remain confident that the US Treasury will be able to pay its creditors, downgrade or not. And US Treasurys are still the world standard for safe, stable investments that can be converted into cash easily. Other nations with AAA ratings have much smaller economies and issue much less debt. When investors seek safety, they don't have many options other than Treasurys.

Q: If the S&P downgrade isn't driving all this selling, why are the markets plunging now? After all, the US economic data was relatively encouraging on Thursday, when the Dow had its worst one-day point drop since 2008.

A: Things are looking grim in Europe. Central bankers there are trying to prevent Italy and Spain from becoming the latest nations to default on their debts. The European Central Bank on Monday is buying up bonds issued by those countries, to increase demand for them. A default by Spain or Italy would be disastrous for other nations that use the euro and could affect financial companies worldwide.

Q: Are investors more optimistic about stock markets outside the US?

A: Not at all. Stocks around the world have taken a pounding. Even developing markets are vulnerable because of how US and European weakness could reverberate globally.

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