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Stock market corrections can be scary, but they are not crashes

01 Feb, 2022 | Return|

Key highlights:

  • Leading economists are suggesting healthy growth, projected to be 4.2% this year, versus an historic average of 3.5%.

  • The stock market has beaten cash in 91% of all ten-year periods and although there are no guarantees as investments rise and fall, you are still likely to get back more than you put in – as long as you are patient.

  • Perhaps the best argument against an equity crash remains the same, the yields on bonds are still far below the earnings yields on companies’ stocks and so a rush out of the latter seems unlikely.

  • Despite average intra-year declines of 15.5%, annual returns of the FTSE All-Share have been positive over 25 out of 36 years, so the current market setback does not necessarily mean it will be a negative year for stock markets.

 

We do seem to be living through some rather volatile and challenging days in the markets at present, and there is understandably some fear about where this might all be heading. Over the weekend, we have seen some rather excitable headlines after last week’s markets fluctuating fortunes which is catching the eye of investors.

This may seem rather scary, and some higher risk assets such as the cryptocurrencies, smaller companies and fast growing technology stocks have got rather hammered since November, with the more volatile speculative stuff taking the worst of it. The press headlines may well be making the situation feel worse than it is. If we step back we can see that, despite this rough patch of late, equities are still sitting on large gains since the pandemic began.

The decline is not a big standout compared to that seen historically over the last fifty years. As a reminder, the stock market has beaten cash in 91% of all ten-year periods and although there are no guarantees as investments, unlike cash, rise and fall, you are still likely to get back more than you put in – as long as you are patient.

Admittedly, the political and stock market valuations are not particularly reassuring at the moment. Whilst we are heading into an environment where interest rates are on the rise at a time, this coincides with a time where the Bank of England appears likely to reduce its support of the bond markets, known as reducing its quantitative easing or their bond buying program.

While high inflation is currently matched with high growth, the inflationary aspect has more of an influence over consumer confidence, which remains weak. As we have cautioned for some months now, asset valuations are also rather high, which means long-term returns are likely to be lower over the long term.

What is occupying the minds of some at present is that with the Bank of England raising interest rates into a richly valued market, a “rates shock” maybe followed by a “recession panic” as growth expectations slow. Interest rate increases are just beginning and interest rate expectations maybe too low. It can be argued that both stocks, credit and housing markets have been conditioned for indefinite continuation of very low interest rates for years to come, and hence it might only take a couple of rate hikes to cause an “event”.

Sometimes the stock market leads the high street and hence the view that a “rates shock” can potentially cause ”recession fear”. Despite, however, the recent wobble in some of the economic data and the resurgence in energy prices, we are still looking at pretty strong real growth for the UK and world economies. Leading economists are suggesting healthy growth, projected to be 4.2% this year (versus an historic average of 3.5%) with inflation, rather than a stagnation in growth with inflation, known as stagflation. While growth is slowing recently, we still do not know how much of the slowdown is due to the Omicron variant. The big question for this year remains the same as it was a month ago: does Omicron loosen its grip on the world economy, moving demand away from goods and back towards services, cooling inflation a bit, meaning that the central banks, like the Bank of England, can raise interest rates at a slow rather stately pace? Let’s hope so.

Perhaps the best argument against an equity crash rather than a correction remains the same, too. It is that the yields on bonds are still far below the earnings yields on companies’ stocks and so a rush out of the latter seems unlikely.

This may appear to be a scary moment and yes things could go wrong as market corrections and shifts in policy regimes often create uncertainty, but it does not look like the edge of an abyss. Investment banks such as Goldman Sachs and JP Morgan have concluded this last week, stating that stock markets are not in the danger zone. Schroders, the UK fund manager, has argued that inflation will, indeed, be transitory, killed by advances in technology, the ageing population (we consume less as we get older) and a revival in global trade.

The current market jitters are not a surprise, it still appears, however, that the stock market direction will revert to its upwards direction once the current dust settles.

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