THE DJIA (Dow Jones Industrial Average) fell by 1,175 points on Monday, its biggest ever one-day fall in nominal terms.
Panic broke after the 50-day moving average support was breached. This triggered more selling that led to the decline. Although the DJIA is only made up of 30 constituent stocks, its direction typically has a psychological impact on global markets.
After its plunge, Asian stock markets fell steeply on Tuesday, led by the Tokyo and Hong Kong bourses.
All eyes were on the DJIA later in the global day on Tuesday and it ended up more than 500 points, though not before dropping by as much as 567 points after the opening bell.
This volatility is not going to be helpful in getting market players to relax about what is to come. With the blue-chip index still up by about 20% over the last 12 months, there is a lot of potential downside to come if the concerns that led to Monday’s plunge sustain.
“Expert” Explanations Abound
When stocks fall this much, stock market experts are wheeled out by the financial media to offer an explanation. After cheering the markets on for the last 12 months, these experts and the media have had to tread carefully. They have to think of explanations that sound logical and perhaps affirm their bullish stance in the previous 12 months.
One seemingly credible explanation that has emerged is that some large-scale investors like brokerages with large accounts are nervous about inflation due to clear signs of wage growth in the US. These investors are also concerned that the Federal Reserve might continue to raise rates, making it more expensive for companies to borrow and invest money. As a result, a combination of higher inflation, higher wage growth and less corporate investment would mean smaller profits for companies. And as share prices reflect earnings expectations for companies, this would, in turn, result in share price weakness.
This all sounds logical, and if it’s true, it is unlikely to have happened overnight. So, it was missed by many experts as stocks were rising. And it will likely be forgotten if Monday’s decline is seen as a blip and stocks start to rise again. This may sound illogical but that is how markets tend to work these days.
If you lived through the lead-ups to the Asian Financial Crisis in 1997-98, the dot-com bubble around the turn of the century and the Global Financial Crisis (GFC) in 2008, you may find this sort of behaviour by experts and the financial media familiar.
In those crises, there was an overwhelming view that there was no bubble forming. Then, the bubble that didn’t exist burst, hurting many global economies for a while.
The current situation with global markets has the same feel as the previous crises cycles. Why have US stocks risen in the first place?
The cheerleaders will point to improving fundamentals and economic data but there are some other key factors in place that are not often covered in the mainstream financial media.
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3 Reasons For The Drop
First, US stocks have been driven up by corporate stock buybacks and dividend increases, fuelled by the easy money policy of the Federal Research, post GFC. This means that companies are not investing in earnings growth opportunities which ultimately support share prices and fuel their upside. But this is fine as share prices continue to rise.
In Singaporean terms, it is a case of “ownself praise ownself”.
Second, exchange-traded funds (ETFs) form a significant percentage of all stock transactions and some see them as having distorted share prices because component stocks of ETFs are bought without research and any regard for their valuations.
As such, money moving into ETFs will, by design, lift the stocks that make them up, regardless of underlying fundamentals. This can be likened to a teacher giving everyone in the class an A for an exam regardless of how well they did in the exam because it makes the whole class, and the teacher, look good.
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Third, just like we saw in the major crises in the last three decades, speculation has also driven the rise in US stocks. There is little regard to underlying fundamentals but a lot of regard for making a quick, easy buck.
Currency speculation led to the Asian Financial Crisis, speculation in dotcoms led to the dotcom crash while speculation in a dubious mosaic of subprime mortgages was seen as the culprit in the GFC.
Slap And Relapse
Lessons learnt from financial crises are quickly forgotten and history seems to be repeating itself right now.
The steep declines in the DJIA and Asian stocks in recent days could be a signal that it is time to exit the market, if you haven’t already.
When the next global crisis comes, which could be sometime this year, it is hoped that the solutions put forward by those in charge of financial markets are sustainable and eco-friendly—that is, they don’t favour certain segments to the detriment of others. Otherwise, global markets will remain caught in a continuing loop of financial crises.
Thus It Was Unboxed by One-Five-Four Analytics presents alternative angles to current events. Reach us at [email protected]
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