Three Reasons Not to Worry about the Stock Market Crash

13 Feb Three Reasons Not to Worry about the Stock Market Crash

We’ve been here before

First of all, market adjustments of the magnitude just suffered are not unseen in financial markets.

Between 1987 and 2018, the Dow Jones suffered declines of 4 per cent or greater 37 times — that is more than once a year.

Even considering the period following the 2007-08 financial crisis, the Dow has declined more than 4 per cent once a year.

The Nasdaq index is even more volatile: between 2002 and 2018, it has fallen 4 per cent or more 176 times, or almost 10 times a year.

And after the financial crisis, the Nasdaq suffered similar such negative returns on 52 occasions.

No real news

More importantly, we have not had important economic news which would justify an impending market crash.

Panics happen when markets rise irrationally, as happened during the dotcom bubble.

The recent rise in the market has not been irrational.

All market participants, even if marginally informed, should be aware that market performance in 2017 was stellar and in line with corporate earnings and expectations of future growth.

I believe a severe market correction will be associated with either geopolitical events, such as wars or terrorism, or to decisions of economic policy that will not be welcome by financial markets. Neither one has happened.

Besides Donald Trump’s tax reform (which should benefit company earnings), the US administration has not made any other big decisions yet.

Fundamentals are solid

Finally, the fundamental properties of both the companies that saw a sell-off in their stocks as well as the wider economy, remain solid.

We are returning to positive and significant economic growth rates, fuelled by Asia, but also accompanied by good perspectives in Europe and the United States.

Corporate earnings are excellent, with reports that profitability in the US corporate sector were at their best in the last 17 years.

On average, 78 per cent of all companies had beaten market expectations regarding earnings growth.

This reinforces the fact that the fundamentals of most companies are not overinflated.

Does this mean that we should expect a rapid market readjustment and that we will enjoy a happy and bullish stock market in 2018? Not necessarily.

The major risks of the world economy remain: China and its massive private debt levels; geopolitical risks, such as tensions between the US and North Korea; increasing levels of income inequality and the potential for subsequent social unrest; and terrorism as a source of global instability.

Time will tell.

Arturo Bris is professor of finance at IMD Business School.  Originally published in The Conversation




Forsythes Business and Financial Advisors
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