Here's why a single report on Deutsche Bank can hit the markets

Why Deutsche Bank hit the market so hard

The markets were fairly quiet midday, with traders focused on the public flaying of Wells Fargo CEO John Stumpf in Congress, when a report from Bloomberg on Deutsche Bank dropped the markets.

It wasn't much. The outlet reported that some hedge funds that clear derivatives trades with the bank had withdrawn some positions, "a sign of counterparties'" mounting concerns about doing business with Europe's largest investment bank.

Not much, but it revived long-dormant memories of 2008.

Deutsche Bank's U.S.-traded shares dropped 7 percent. European banks that trade in the U.S. fell roughly 3 percent.

The shed 15 points in a matter of minutes.

U.S. banks dropped, as well. JPMorgan Chase lost 1.5 percent.

Wait a minute. What do (possible) issues at Deutsche Bank have to do with JPMorgan?

And why would the entire market drop? Everything dropped: consumer staples, consumer discretionary and health care. Even Whirlpool fell $2.

What's Whirlpool got to do with Deutsche Bank?

Michael Nagle | Bloomberg | Getty Images

On the surface, not much. But in the post-financial crisis worldview, it doesn't take much.

The logic goes like this:

  1. If Deutsche Bank did go under, it's not a positive. You would have a big distressed international seller of assets. Consumers would worry. What are the chances that the bank could go under? Very, very small. The German government would almost certainly step in as a last resort. But — this is the post-financial crisis mindset — the chances are not zero.
  2. A lot of things no one thought were correlated turned out to be correlated in 2008. Problems at Deutsche Bank could lead to higher credit costs and slower economic growth.
  3. Markets hate uncertainty. Counterparty risk creates uncertainty. This was the central lesson from the Lehman crisis.

You get the point. A slightly paranoid worldview is still very prevalent about banks that have trouble. Paranoid, but not completely absurd.

But what about the rest of the market? Why exactly did, say, Whirlpool drop $2?

First, the market trend in many sectors (health care, consumer staples) was already down before the story came out.

But the more important reason is that today's trading action is dominated by traders who will pull bids when there is market uncertainty. When you have heavier volume with fewer bids, prices drop to attract buyers. Throw in trend following programs and that will more than adequately explain how stocks that are not correlated could drop together.