Why The Stock Market JUST Dropped

What's up, Graham? It's guys you here, and I know I always preach the age-old sayings: don't time the market, buy and hold; time in the market beats timing the market; the stock market is not the economy; and the market can remain irrational longer than you can remain solvent. But you can't deny that right now there are some really wild forces at play that impact all of us as investors, at least in the short term, that are worth covering. Because, at the very least, it's entertaining to learn about, and at the very best, maybe understanding how these work will help save you some money.

That's why we got to talk about exactly what's going on right now. We'll cover some of the stock market drama that's behind the S&P 500 potentially having its worst September in almost 10 years, and we'll explain the recent stock market sell-off, along with some other investor traps that everyone needs to be made aware of. But really quick, I got to tell you about the single best, most profitable investment that you can make in less than a second. It's the ticker symbol: smash the like button for the YouTube algorithm!

In fact, the like button is up a thousand percent over the last two years, and it's on pace to reach its next all-time high with your help. So just give it a quick tap. It helps me out a lot; I really appreciate it. Thank you so much, and let's begin over here.

Okay, so this is what's been going on, and here's a very simple "explain like I'm 5" version just to get everyone caught up to speed. Prior to 2020, the stock market has seen some rather great growth. Besides a brief sell-off from September to December of 2018, it's gone up rather consistently for nearly 10 years. That is, of course, until everything happened. This caused our entire economy to shut down; stay-at-home orders were put in place, international travel and manufacturing were restricted, and the entire market, rightfully so, dropped significantly day after day.

But then something interesting happened. The Fed came in and lowered interest rates. Several large stimulus proposals went into effect—trillions of dollars began pouring back into the economy. Not only did the markets begin to recover, but tech stocks ended up doing incredibly well as people were forced to stay at home and find other alternatives. So much so that it boosted the S&P 500 to its all-time high, and the Nasdaq hit its all-time high by over 25 percent. Let again buy tech stocks.

But then stocks ended up going down. Within three weeks, the S&P 500 has declined about 10 percent, and the Nasdaq about 12. Many other stocks are down even more than that, which leads to the question: what's going on? How much longer can this last, and is it a good idea to buy in, or is it like catching a falling knife?

First, in terms of why the market is going down, here's what's coming into play all at the exact same time. One is political elections that are coming up in November, and there isn't really a clear outcome. You guys know me: I don't talk about politics ever here in the channel, but the thing is, deep down, what every investor dislikes the most is uncertainty. Investors don't know how policies might change over the next few years; they don't know how tax rates might affect them. They also don't know how to base their future projections.

And because of that, most investors and analysts will play it a little bit safer and be a little bit more cautious because they don't know what's going to happen. Now here's the thing: when we talk about elections, every now and then I like to go down the rabbit hole of research and get consumed in the internet. Actually, what I found was pretty interesting. LPL Financial analyzed the average stock market return over the last 70 years for every single year, including election years, and they found that, on average, the September of an election year saw a negative stock market return followed by a more volatile October before eventually rebounding again in November and December.

Of course, all of this is very easy to point to in hindsight, and it's also very easy to cherry-pick examples like this as a way to back up whatever you want to prove. But even still, the uncertainty of politics right before an election is usually enough to make investors feel a little bit more nervous, and that, in turn, applies to the prices of what they're willing to buy and sell. But still, overall, not all election years are bad. If we look all the way back to 1928, the market has gone up 19 out of 23 times during the entire year of an election.

Now, that doesn't always mean that past performance will be repeating itself again and again, but overall it does go to show you that short term anything can happen, but overall long term you're going to be seeing more gains than you are losses. The second factor at play is that the UK is experiencing an increase in cases, and there's a concern right now that they might go into another lockdown for another two weeks. As of now, the Prime Minister plans to introduce stricter measures on the public, including a possible 10 PM curfew.

It's still unclear if this is going to happen, but like I mentioned, uncertainty around anything usually does not bode well for investors, especially if those measures could be carried across an entire nation impacting the economy. That's also on top of another rather unique story that broke this morning about some questionable bank transactions. The allegation is that, over the last 20 years, some banks have participated in an intricate $2 trillion money laundering scheme tied to some dodgy transactions.

As an easy way to sum this up: leaked documents claim that banks have turned a blind eye to accepting corrupt money that was flowing through their accounts from 1999 to 2017. As it is right now, banks are required to write up suspicious activity reports for any high dollar or questionable transactions, and this is a regulation put in place to make sure everything operates as it should. But it was found that some of these suspicious activity reports weren't written up until months after the transactions took place, and then many of them from there were just never followed up with at all.

Essentially, this is true: either banks are really bad at keeping tabs on these types of things, or they turned a blind eye because they were making money from some of these high net worth individuals. Now, some compliance experts argue that banks are having a difficult time distinguishing between suspicious and non-suspicious activity, so filing millions of reports would overload the enforcement agencies. They also say they're dealing with a backlog of false positives, which is why it usually takes a few months for these reports to be written up.

Now, who knows what's true and what's not? It's too early to tell, but the two trillion dollar amount was enough to certainly rattle the markets and absolutely send bank stocks declining even further. There’s also the concern of another round of stimulus being delayed, as it has been for months now. If you take all of that and then combine it together, that's why the market has been a little bit volatile lately.

And lastly, this is probably the most relevant to most of you watching, especially if you do not want to lose money in the markets, and that would be this one word: debt. I mean, it's no surprise that stock trading has become a lot more interesting once the market dropped and everyone was stuck at home. Like, if we look back, new accounts opened on Robinhood and Charles Schwab increased exponentially in the last few months. And now something else has risen alongside it, and no, it's not the like button; it is margin trading.

Yahoo recently reported that 43% of retail traders are now trading with leverage. And then if we go and break that down even further, we can see that 23% are trading just using options, and 10% are just using margin. For those of you that don't know what options trading is, this is when an investor pays for the right to buy a certain stock at a certain price by a certain date.

Like, I could go and say I'll pay one dollar for the right to buy Tesla stock at $450 by October 31st. Now, if the price of Tesla stock goes above $451, which is the price of the stock plus the one dollar option I paid, I could make money—in fact, I could make a lot of money. That's because each option contract is the right to buy 100 shares, so my investment is then magnified 100 times. That's a recipe to either make a lot of money or lose a lot of money.

So now, in the last year, options trading has increased in popularity by 45%, and when we look back historically, we could see that options trading exploded in volume over the last 12 months and began their slow trickle upwards once Robinhood was introduced and then once brokerages began offering free stock trading. Of course, you might be wondering, "Why does this even matter, Graham? I don't even buy options. Why should I care?"

Well, the reality is that options can impact the entire market as more and more of your investments are held up by leverage and cheap money. That could explain some of the volatility in today's market. Like, Goldman Sachs estimated that now 20% of all S&P 500 options traded in the second quarter had a maturity of less than 24 hours, up from 5% in 2011 to 2016. Or, in other words, that means that people are now leveraging their money 100 times on short-term speculative bets on where the stock market is gonna head in the next 24 hours.

This has the potential to intensify the normal swings in the market, for better or for worse, because of how this is all facilitated. See, if you go and buy a call option with the expectation the market is going to be going up, many brokerages will actually go and buy that underlying stock as a hedge against their position. Multiply that by tens of thousands of call options spread across the entire S&P 500, then multiplied by 100 times, and that easily creates this wave that pushes the market higher and higher and higher, and then lower and lower and lower as people sell off.

That led to the notion that maybe tech call options have influenced the entire market to rise abnormally fast and then dip quicker than expected as investors bought up and then sold their positions. Bloomberg even joked that the reason the stock market rally abruptly ended on September 2nd was because Robinhood investors had to go back to school.

Anyway, I would like to think this would be a critical warning out there for any new investors to preferably not trade stocks with leverage. I think the fact that 43% of investors are trading with leverage, or margin, or options, is rather concerning, and I guarantee this can't end well. It's only a matter of time until people end up losing money, and I also have a feeling that eventually, options trading is going to be further scrutinized and regulated as it continues growing in popularity.

This might be an unpopular opinion, but the way I see it is that for a lot of people out there, options trading is just an easy means of gambling disguised under the look of investing. I think unless you really know what you're doing, there's a high likelihood of you losing money. I just think it's too easy for anyone to sign up for an account, throw in a few hundred dollars, and then trade that times 100 with no experience whatsoever. And it's likely gonna take a big event for people to look into this further and for new measures to be put in place.

Until then, it does seem like investors are beginning to acknowledge that mom-and-pop retail traders have the power to influence the market through options. As more and more people pile into the stock market times a hundred, we could continue to see some pretty crazy swings.

So yeah, I mean, obviously, you know I'm going to say the same: buy and hold, like I've been repeating non-stop for the last few years, even while the market was dropping 40%. If you've watched just even a few of my videos, this should really be no surprise by now. But I do want to use this as the time to caution you that you should expect more volatility like this over the next few months.

You should also understand how options trading is going to magnify those swings, for better or for worse. You should make sure you don't trade on options or trade margin unless you really know what you're doing or you have the money to risk. If you want to play around with some fun money because you're bored, then by all means. But if this is serious money that you're investing to build wealth or use towards retirement, I would stay away from margin and options and just buy what you could afford with the intention of holding it long term.

I know it's appealing to use free money or low-interest rate loans right now. I know some brokerages are offering you 2% interest on margin on your entire portfolio, which is insane—it's ridiculously low. But be aware there's significant risk of those loans being called if you're not careful about what you're doing. The safest strategy out there is just to buy what you could afford with the intention of holding it long term—of 20 years or more—and then obviously smashing the like button for the YouTube algorithm.

So with that said, you guys, thank you so much for watching! I really appreciate it. Make sure to destroy the subscribe button and the notification bell. Also, feel free to add me on Instagram; I post pretty much daily. So if you want to be a part of it there, feel free to add me there. As for my second channel, The Graham Stephan Show, I post there every single day—I'm not posting here. So if you want to see a brand new video from me every single day, make sure to add yourself to that.

And lastly, if you want a totally free stock, use the link down below in the description, and Weeble is gonna be giving you a free stock worth at minimum $8 and all the way up to $1,600 when you deposit $100 on the platform. So feel free, enjoy that free stock, and let me know which one you get. Thank you so much for watching, and until next time!