I don't think I understand how subprime lending affects the overall stock market. Some companies will go bankrupt? Obviously people who have stock in those comapnies lose out. But how does that translate into market losses across the board?
Here are a couple of the better explanations I've read is as follows:
The recent number of mortgaging companies experiencing problems reflects on the state of the country's economy. The more confidence there is in the economy, the more willing people are to invest in the stock market. If there are doubts amongst the investors, they will tend to move their money to safer, less riskier forms of investment like US Treasuries. This means selling their stocks to get their dollars back and then putting their dollars in Treasuries. This is another reason stock prices will go down.
Companies use the interest from the loans to create more loans for other businesses and other purposes, and so, when the housing markets melt down there is not as much money to loan out, and that has a ripple effect on everything else. Also, consumers who have rising interest start curbing their expenses, so the demand for products go down, and so companies suffer.
Now for your other questions.
What other factors are influencing the recent market conditions? I'm losing money in my index funds and I don't understand why.
In the long term, does it really matter? Right now we may be seeing a housing bubble burst. At worst so far, we've seen the Dow fall less than 6% from it's closing high of 14,000. As of market close yesterday, that loss had been cut to less than 4%. So maybe we're seeing a housing bubble burst due to the sub-prime mess; maybe we're not. In 2000-2002, we watched the tech bubble burst. Yet in 2007, we saw both the Dow and S&P500 reach new highs. The NASDAQ (which is tech-heavy) still hasn't recovered.
What does all this tell us? It tells us that given time, the market overall always recovers and over the long term, it will always trend upward. The NASDAQ story tells us that we probably shouldn't be overinvested in any one sector. And how do we avoid overinvesting in a single sector? By investing in an index fund that covers the total stock market. During the bear years of 2000-2002, I continued to invest on a regular basis. Let me tell you, it was plenty discouraging to see my balance go down every month even after I'd put in more money. There were times when I wanted to give up, but I stuck with it. In the end, not only did I recover every dollar I'd lost by 2007, but I'd made money (quite a bit of it) because every dollar I'd invested while the market was going down had gained while the market was recovering.
Are you going to have bad months? Of course! Last month was a bad month! Are you going to have bad years? Yes! I had 3 of them in a row! Most people did! But stick with your investment plan and you will be rewarded. This is about getting rich slowly
. Now when the market goes down, I think of it as shares going on sale. I don't rush in and buy more though, because I have no idea where the bottom is. When the market goes up, I have no idea where the top might be. I just stay disciplined, investing according to my plan over time. I didn't have to figure out there the market was going or how long it was going to go in that direction. I just invested on a regular basis. It's boring, but it works. You can get even more diversification by investing in an international index fund to go along with your domestic index fund. That way you can be invested globally, not just domestically.