A global stock market downturn?

Last Thursday, October 11, almost all of the world’s major stock market indices fell by between 2 and 3 percent. While not a very large drop as compared to other downturns during the Asian crisis and the Wall Street meltdown, it is worrisome as it cut across Asia, Europe, and the US. The Dow Jones fell 3.2 percent overnight; the British FTSI, the French CAC, the Singapore, Shanghai, Hong Kong and the Japanese stock indices also went down by almost the same percentages. The Philippine Stock Exchange Index (PSEI) also dropped by 1.8 percent, hitting a low of 6,884 at the closing bell. The immediate cause of the downturn cited were: the US Federal Reserve Board (FED) decision to raise US interest rates which lifted the Treasury rates, Trump’s sharp public criticism of the Fed’s action, the escalation of the China-US trade war, and the jump in oil prices. All these have worldwide implications on trade costs and volume and the cost of funding. In the Philippines, these aggravates the current account deficit in foreign exchange, further weakening the peso and stoking the already-high inflation.

These short-term causes are valid and could be addressed on the immediate resolutions of the issues. However, there are deeper underlying causes that are political and may prevent the resolution of the oil pricing and the trade war that may engulf other countries beyond China and the US. The world trade volume growth will slow down affecting the world economic/GDP growth, which will be more severe in the developing countries. The stock valuations in the exchanges all over the world have been inflating on the expectations of a fast-growing world economy, and the price to earnings (P/E) ratios have been exceeding 20 times. A simultaneous slowing of the major world economies will surely bring down these ratios to the more conservative/historical 10 times.

The general expectation is continued volatility of the stock markets with a downward bias. There is also the perception that the bullish stock market may be due for a correction considering the long years it has been in the upswing. Natural cycles cannot be discounted, especially in view of the overvaluation of some stocks, which were driven mostly by the excessive liquidity in all the markets, that the central  banks are now reining in to prevent overheating and slow down the inflation rates. This will have a sobering effect on politicians who have been riding on the excess liquidity to push their populist agenda. Funding populist programs and projects will be costlier financially and politically.

In the Philippines, only 7 percent of the population are invested in the stock market, including those who invest in mutual funds and index funds. These are those with high disposable incomes and have savings. With two dependents, the behavior of the Philippine stock market will at most affect 20 percent of the population. But it is a leading indicator of the future of the economy, so it will be telling on the economy 2 to 3 years down the road. For the individual investor, this could be the time to review your investment allocation with the target of keeping your stock investments in the 5 to 10 percent range; bonds at 20 percent; time deposits and money market placements at 20 percent; property and real estate at 25 percent; and your own business at 25 percent. The stock market is a good avenue for investments but you have to understand it by studying and talking to the experts. I did a thesis on the stock market in my MBA, so if I really study some stocks and the cycles, I minimize the risk of loss. While there are no loss-proof stock market investments, having a investment horizon of seven years allows you to ride the cycles and ends up with profits most of the time.