By now, global stock indexes have fallen around 4-5% from their 2007’s highs. No one is quite sure why the correction happened. Certainly not many people predicted that a sharp correction was in the play for this month. So after the correction on Wednesday, many analysts came up with what they think were the causes of the correction. However, it is worth bearing in mind that stock markets are an aggregator of human actions and are hardly predictable. All these reasons are in hindsight and the reasons for any further corrections in the market might not be the same reasons.
1. The Greenspan Effect
He said “it was “possible” the U.S. economy would go into recession in the second half of 2007.” Given that Greenspan was the previous US Federal Reserve Chairperson; his words do hold sway over the stock market. But whether if his words were coincidental timing or words of wisdom, it is hard to know.
2. News that the State Council, China’s highest ruling body, approved a special task force to clamp down on illegal share offerings and other banned activities in the market. This piece of news created quite a bit of negative sentiment in the markets. Which then lead to China’s Shanghai Composite Index dropping almost 9 percent on fears that the government would crack down on speculation that has driven stock prices there to record highs.
Another case of a high authority muttering words that had a large effect on the economy. This correction also marks the first time that a correction is China’s stock market affecting global equity markets.
3. Investors might be taking profits as the Shanghai Composite index had been up over 100% in CNY terms in 2006.
You often see profit taking as a reason for correction. If you read financial news regularly, you will notice that this reason is always taken out as an excuse for a low of downward movement in the markets.
4. “Technical indicators have for more than a month indicated that global equity markets were overbought, therefore the current correction is best interpreted as an overdue reduction of risk in portfolios,” explained Tom Elliot from, JPMorgan Asset Management.
Technical analysis is the prediction of market moves from changes in prices. There are elaborate techniques for technical analysis. The basic belief is that all decisions are reflected in price moves and predictions can be made from previous price moves.
5. Global traders may have been unwinding yen “carry trade” positions due to worries about the U.S. and Chinese economies
Carry trade is : “A strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate”
In our case, Japan Yen has a very low interest rate so investors borrow money from there and purchase assets with better returns elsewhere. However there are dangers inherent in this approach. Your returns might be undermined by the exchange rate between the Yen and the asset that you are investing in. Ultra cheap credit can also mean that speculative bubbles all over the world are formed in areas like high-yielding and second-tier currencies, trophy real estate, high-yielding bonds, art and possibly even gold.
6. A government report showed a much bigger-than-expected drop of 7.8 percent in January’s new orders for U.S.-made durable goods, which added to concerns about a slowdown in economic growth. Durable goods are big-ticket items, including home appliances and computers, intended to last three years or more.
Durable goods are more elastic to changes in the demand curve in the short run. A reduction in purchase of durable goods usually means that consumers are spending less and avoiding big ticket items.
7. Considering just how quickly the world’s stock markets have rallied since the start of the year, a correction has been on the cards – and that is what we are now witnessing.
Remember the adage “What goes up must come down”? Here we are seeing the investor in keeping with the phrase. It is usually another excuse to explain the correction. However it does not explain why the correction is happening now.
8. It was triggered by a widening of credit spreads in the US sub-prime mortgage market
“The subprime market is overloaded with bad loans that have effectively smashed holes into the hull of this financial ship. It has been surprisingly easy for people buying a new house to borrow hundreds of thousands of dollars by simply telling the bank how much money they make - without any proof.”
When loans are given out to people who might not have the ability to repay them, the mortgage companies take on additional risk. And as interest rate rise, the homeowners might not be able to pay the additional interest leading to a bad loan and loss on the mortgage company’s book. All in all, it means money is being taken out from housing and the stock market. Easy credit is withdrawn leading to a fall in spending which is the precursor of a recession.
9. Temporary repricing of risk and that investors will begin to refocus on positive fundamentals in the very near future.
Another reason used to explain movements in the stock market. See No. 4 and No. 7.
10. More Real Money thinking that it will fall further than it going up.
Stock markets are simple things. If more Real Money (People* The money they are using in the stock market) bets on a correction, a correction happens. If more Real Money bets on a bull market, the market rises. There is a quote in the stock market: “In a market, there is a willing buyer and seller, yet one thinks he is getting out before a fall, another thinks he is getting a bargain”
Who is right? Who knows? I certainly do not. And frankly I have learnt to ignore movements in the market. I believe in putting money into my investment regularly and keeping my eyes shut. To see how to manage your money, look here-> Top 10 Money Tips For Almost Everyone
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Welcome to the May 6, 2007 edition of top ten list carnival. This edition is rather interesting. Of personal interest is the post about insurance from Silicon Valley Blogger(10 Tips On Life and Disability Insurance: How And Why We’re Getting More). I am going to Silicon Valley around the end July for my 1 year internship so I am looking at insurance options for the duration.
Hmm… today’s topic is really quite a change from the usual techie stuff. We are getting serious today. Top 10 stock recommendations are everywhere on the internet and most of them are just spam. However I have been using MSN Money Portfolio since 2003 and have seen it go through with many upgrades. Back then, even from 2003, at the end of every year, they would pull out their Top 10 stocks for the previous year and show you how much gain you could have made. The performance of their portfolio usually outranked the market index and my own. So far their Top 10 portfolio, revamped every year is up 339% since 2001. S&P 500 is only up 10.2%. Amazing right? My portfolio from 2003 is only up 50%. Wow! When I read this article, I was thinking that I might as well put my money into the Top 10 stocks they recommended instead.