The real reason for the stock market’s 7% plunge

Here’s why the U.S. stock market plunged on Thursday: Too many bulls. You’ll hear other explanations, such as the risk of a second wave of COVID-19 infections and the Fed’s grim outlook for the U.S. economy. But such factors can’t really explain why the Dow Jones Industrial Average lost 6.9% while the S&P 500 fell 5.9% on Thursday.

After all, new COVID-19 cases have been disturbingly high for several weeks; the number reported on Thursday was not significantly different than any other day of recent weeks. And for some time now health experts have been expressing concern about a potentially even more lethal second wave of infections this coming winter.

One indicator that helps fill this explanatory void is market sentiment. Only this week did bullishness among short-term market timers start to reach a dangerous extreme; contrarians therefore were not particularly surprised by Thursday’s decline.

As recently as a week ago, short-term stock market timers were “surprisingly subdued.” Because of that, contrarians were predicting that “the Nasdaq is likely to hit an all-time high.” The Nasdaq Composite did indeed reach a new high earlier this week, closing above the 10,000 level on Wednesday — only to lose 5.3% a day later.

Unfortunately for stock investors’ near-term prospects, market-timer sentiment won’t shift back to supporting higher prices until there’s a lot more skepticism. Thursday’s plunge started that process, but there’s a long way to go.

The real reason for the stock market’s 7% plunge shouldn’t surprise you — and it happens every time, MarketWatch, Jun 12