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A 'Flash Crash' Course

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar. We waited a whole year to have a retrospective of the Bear Stearns and Lehman Brothers collapse, but with last Thursday's Flash Crash being so brief, we figured why wait a year, we can do it in a week.

Here with me to talk about lessons from the Flash Recovery is Morningstar Markets editor Jeremy Glaser. Jeremy, thanks for joining me.

Jeremy Glaser: Jason, it's been quite a week and I'm glad we can finally recap all of it for people.

Stipp: A very eventful week filled with insights from the flash recovery. You've got five of them, what are they?

Glaser: First we'll see how volatility reared it's ugly head, then we're going to take a look at how governments are willing to change things very quickly and how things can change very rapidly. We'll see that Europe is likely to going to lag behind the rest of the world for some time. That sometimes Wall Street doesn't know what's going on. And finally we'll take a look to see if consumers were able to survive the crash and spend throughout the recovery.

Stipp: I think one of the lasting things that's seared into investors' minds is volatility. That seems like a great place to start.

Glaser: Yeah, we haven't seen this kind of volatility since the end of 2008, and early 2009. And through this last year we've almost been lulled into a sense of security again. Oh, stock prices always tend to go up and we're not going to see these huge swings.

But that's just not the case. When you buy a stock you're getting paid a risk premium, and you're getting paid a premium because stocks are in fact risky. And you would expect to see some of these really big swings.

Now 10 percent in one day? That's certainly extreme. But it's something that's completely unheard of or something that's completely impossible. So it reminds investors that buying stocks is a risky proposition, it's something you want to think about over long term. You need to be prepared to stomach a bunch of volatility. If you can't, maybe stocks aren't where a lot of your portfolio should be.

Stipp: I think the volatility, they're still trying to figure out exactly what caused that and what they might implement to try to fix it in the future. But there were jitters because of Europe last week, and we also saw some action taken there to hopefully soothe the markets.

What's the lesson from all of the action we saw in Europe?

Glaser: I think we learned a few things from this crisis over this last week, about what Europe is willing to do.

First off, they're willing to do basically anything. The idea of sort of sovereign default within the euro zone was just unacceptable to them, and they're willing to take any steps necessary in order to stem the risk.

Now this is why the markets responded so positively, because they saw the potential of this risk becoming more remote. But it just shows in general that governments are willing to nip these systemic risks in the bud, where before they might have let them play out a little bit longer.

And also it just shows to investors how quickly the facts on the ground can change. The idea that the European Union might start having further policing of fiscal policies of individual members or issue Eurobonds would have seemed crazy just a few weeks ago, and someone would have laughed at now. And it now looks like they're probably going to happen and seem plausible. So things change pretty rapidly.

Stipp: Well, certainly the relief rally that we saw this week, it shows maybe kudos to them for the short term fix, but this doesn't solve all the problems in Europe, right?

Glaser: Absolutely not. The problem is that Europe is not growing fast enough. That you see expenses in the member countries continue to grow, but revenues aren't getting any larger because the economy's not growing.

We saw GDP numbers this week that kind of supported that there's some slight growth, but that a lot of the euro zone and a lot of Europe in general is still in recession, and it could take a long time for them to emerge from that.

Now the United States is doing better for the most part Asia is doing better. A lot of the developing world is doing better. So the question is, do we have a decoupled world society? I talked about this a lot before the other crisis, in which Europe can continue to lag but the rest of the world can see robust growth.

Or does Europe have to be running on all cylinders for the rest of the world to recover? That's the open question, I think one that's going to be important in the coming months.

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Stipp: Sure. And speaking of open questions, how many rumors have we heard about what caused the flash crash? I think I've heard everything, except I'm waiting to hear about somebody's cat walking across the trading desk and causing this huge trade.

I don't know if we know what it is. I don't know if Wall Street knows that it is. But what's the lesson from that as an investor? Is just the whole world in chaos because of this?

Glaser: You're right nobody knows. Wall Street doesn't know either. And I think that's an important fact. It's easy for individuals to see all this flash trading and to hear about how the Wall Street banks just make so much money.

Goldman didn't lose money on a single trading day throughout the first quarter. And you think that there's no way as individual investor you could ever compete with that.

But it shows that A) Wall Street does not always know what they're talking about, and that oftentimes they're just going to get as confused by these events as individual investors are.

And then secondly, that individual investors who have that long term horizon, who are buying and holding, who are really just thinking about what the value of these companies is over many, many years instead of over many, many seconds, it gives the opportunity to really make that money and compound their wealth over time.

So I believe if you were not watching the market for that 20 minutes and didn't see the 10 percent and didn't have stop-loss order or anything like that, you probably weren't that concerned about the whole flash crash. It shows how important that long term perspective is.

Stipp: It's possible that some people missed the flash crash because they were out shopping.

Glaser: Yeah, it's amazing that apparently nothing can keep the American consumer down. Not even some fundamental jitters about the solvency of Europe can keep people out of Kohl's or Macy's or Urban Outfitters, all of which had pretty great quarters.

Obviously it doesn't include the last week, but everything we've heard about traffic and everything we've seen about sales is that consumers are back at the mall, consumers are back spending money, buying what they need, and not being so concerned about the future of their job or the future of the rest of the economy.

We'll see if it's sustainable, but the consumer looks like they're back for now.

Stipp: Jeremy, thanks for you flash retrospective.

Glaser: You're very welcome.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.