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The Facts Behind the Stock Market Crash

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History has taught us that when the doomsters are out in full force, we’re towards the end of the sell-off….writes Sukhvinder Gill

China StockSo there we have it, European and Japanese Stock Markets are now in a Bear phase, with the US not far behind.

The definition of a “Bear Market” is a fall in prices of 20% or more.

Should we be worried about a further rout, go out and buy dried food & automatic weapons and then retreat to an underground bunker?   Let me put this into context.

Stock markets move in 3 directions: Up, Down, Sideways. Stocks have historically outperformed most other asset classes (£1,000 invested in 1987 would be worth £10,000 now, assuming the dividend income had been reinvested). The price we pay for this stellar performance is occasional volatility.

A stock price simply put is: the discounted value of its future cash flows. So if a stock’s price is falling the market thinks that the company will be generating lower profits and/or interest rates are rising.

The oil price collapse and the slowing Chinese economy suggest a slowing global economy, so that’s the first of our conditions satisfied (i.e. lower corporate profits). The US Fed increased interest rates in Dec 2015, so we’ve got a full house with respect to the “text book” criteria required for falling stock markets.

Of course this scientific way of computing a stock price is far from the reality. Markets work on expectations and fears (and we can’t accurately attach a value to this for any computation). The rallies and the sell offs are often rapid which exaggerates the moves. Markets are rarely at “fair value.” Historically big falls have triggered big bounces. Calling the bottom is a pointless exercise, but money needs to find a home and ultimately the stock markets have a great allure.

History has taught us that when the doomsters are out in full force, we’re towards the end of the sell-off. Markets are forward thinking; today’s news has already been discounted. Markets will likely test lower levels, but I’d be more than surprised if in 2017 we’re not talking about the “great buying opportunity of 2016.”

(Sukhvinder has worked as a Global Business Head and Trader in Capital markets for over 20 years)