With the US DOW Jones index falling 324 points or 2.0% on Friday 24th January, investors have panicked as the Australian Stock Exchange opens following the Australia Day long weekend. By the closing bell Tuesday, the ASX200 index was down 66 points @ 5,175, and after a mild rally, were back at the same point on Thursday. Is this the warning bells of a stock market crash starting to sound?
Fear and Greed are the two emotions that control investing decisions amongst Mum & Dad investors – also referred to professionally as the Retail market. Although most Retail traders perceive stock market investment to be a game of prediction, it is very rare that anyone ever predicts a stock market crash. In fact, euphoria is usually strongest before the biggest stock market crashes.
Rising markets will always instil Greed. Investors hold onto stocks longer than they need to, and when stock prices start falling, hold onto those stocks as they believe the price will come back up to its highs.
But with falling markets, an investor will wear the pain of falling stock prices longer than necessary. In fact, they start selling their shares only once the pain of holding them is far too great. And this action is usually at the bottom of the market.
Panic selling didn’t hit the markets late last week or even early this week. At this stage, what we are experiencing is a stock market correction – a counter-trend movement that aligns market activity back to an average. We have not yet seen a real stock market crash. And yet, the news headlines are reflecting fear and uncertainty, and investors are worried that the boom trend could be at an end.
To define a stock market crash, there is not a specific definition, but it can be considered as strong fall in stock market value, usually in a double digit percentage movement exceeding 10% in value. Normally a crash will occur over a short period of time, although in hindsight a slow/steady fall in the market might be considered a crash if it exceeds normal market movements.
What is driving the current stock market correction?
If Europe and the US are in a recovery, and China is consolidating at 7.7% annual GDP growth rate, then what is the cause of the current global stock market slump?
The answer is the outlier countries. It’s no longer Greece or Italy that is causing fear of another Global credit crunch, it’s now Turkey and Argentina. Turkey doubled interest rates overnight as Inflation is well above their target. This has caused a panic amongst foreign investors who are cashing out of the stock market and looking for safer investments.
A couple of years ago, Cypress, Portugal, Spain, Greece and Italy were problems. But today we are seeing signs of Turkey, Argentina, India and South Africa as the catalyst for why the US stock market is falling.
The upheaval in the Emerging markets is affecting the US and Europe as a ‘flight from Risk’ and search for safety has investors reducing their exposure to these countries.
While Europe and the US is recovering, and China is consolidating, a new cycle of central bank tightening of monetary policy has begun. Interest Rates have started to increase in Emerging Economies while at the same time the US Fed Reserve is reducing its stimulus measures.
The term Fragile Five is now the key phrase that is being used in the media. It refers to the top five economies that are in turmoil globally, including Turkey, Brazil, South Africa, India and Indonesia. These economies are dependent on foreign investment. But foreign investment is decreasing as investors focus on their local economies, and that is stripping the Fragile Five of much needed investment capital.
Could this be the catalyst for a market pullback in 2014? It certainly is a leading concern. Just like the European Financial Crisis had affected global investor confidence in 2011/12 with the likes of Greece, Italy, Spain, Portugal and Cypress (referred to as the PIGS), the Fragile Five are key elements for continued recovery on a global level.
If there is further inflationary concerns in these Fragile Five, then this will have the ability to change the global market environment from one of hopeful continuation from 2013, to uncertainty and an end to the trend.