Regardless, here we are, the morning after an 1,100 pt drop in the Dow (although in "only" closed down about 600 on the day) and back-to-back 7%+ drops in the Chinese stock market. Is it time to panic? Well, not yet. Let me explain.
I believe that three consecutive days of stock market routs have acted like a cold slap across the face of money managers and institutional investors across the globe. It likely snapped them out of the zombie-like, knuckle-dragging, "stocks-can-only-go-up" mentality that they've been in for the last three years. It was, in a phrase, their come-to-Jesus moment. Right now institutional investors (hedge fund managers, pension funds, mutual funds, etc) are looking around saying, "something isn't right here." Stocks like GE and Apple shouldn't move 10% up and down and back up again in a matter of seconds. We're talking about changes in market caps of hundreds of billions of dollars faster than you can count to five. There are fundamental, structural flaws in the way the market operates (here's looking at you HFTs).
Understanding that the market has topped and that the underlying mechanism is broken, fund managers will now look at their big pile of overpriced, overvalued equities and figure out a way to get the hell out without sending prices in a downward spiral. That's where you, dear retail investor, come in. What will happen next is meant to sucker every last buyer into the market. No fund manager wants to be left holding the bag when the market tanks. That's why over the next days, weeks, and possibly months, there will be a massive, institutional investor-funded rip-your-face-off rally that will serve to turn yesterday's fear back into good old fashioned greed. Once they get the rally started, it will turn into a virtuous cycle as momentum-chasing algorithms start buying into the rally. Then, retail investors, who don't want to be left behind but by this point will be late to the party, will start buying. So once institutional investors fire this rally up, algos and retail will take the ball and run with it, allowing those very same institutions to sell into strength that they initiated, ultimately exiting those overpriced, overvalued equities. In graphical terms, this is what it will look like:
After a while, long after institutions have unloaded their shares, the rally will stall and roll over. With big money exiting the market, there won't be any foundation on which to build a sustained upward move. That's when the stuff hits the fan. Greed will turn back to fear and the selling starts anew. Perhaps slowly at first and then in a whoosh (remember, stock take the stairs on the way up but they take the elevator on the way down), the bottom will fall out, as marked by the second dashed blue line.
To summarize, the worst thing that can happen in the markets right now is a hard rally, effectively erasing much of the losses from the previous days. Unfortunately, that's exactly what I think is about to happen.