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February 2018 has been a bad month for the United States stock market. In just two consecutive trading days, the market crashed by more than 1500 points. As a result, all the incremental gains that were made in January 2018 were simply wiped out within these two days. It would be incorrect to say that the fall in markets came as a surprise to anybody.
The market had been extremely bullish for the past few months. It had reached new heights which were earlier thought to be impossible. Hence, there were many skeptics in the stock market who believed that downfall was just around the corner. They also believed that only a catalyst incident was required which would then unleash the pent-up supply and cause a market crash.
In this article, we will have try and understand the common catalyst events that ultimately lead to a downfall in the stock market prices.
Before we begin our analysis, it is essential to differentiate between a crash and a usual correction. Every small downfall in the equity markets cannot be termed as a crash.
A crash happens suddenly and the magnitude is higher. Hence, if the stock market value drops by double digits in a matter of days, it can be called a crash.
However, if there is a gradual reduction spread out over several days and even weeks, then it cannot be called a crash. The correct term to use would be “market correction”
After the 2001 dot-com crisis, interest rates were kept at near zero levels to stimulate demand. This led to the formation of a massive asset bubble which burst in 2008 during the subprime mortgage crisis.
After the subprime mortgage crisis, the government has once again adopted a loose monetary policy. The low-interest rates and quantitative easing have created an unprecedented bubble. The market is now afraid that the gains are unsustainable and will be soon lost to an interest rate hike.
As a result, when the data from the economic survey showed that wages had started rising, it spooked the financial markets. Rising wages are considered to be indicators of inflation. Hence, the market assumed that the Fed would raise the interest rates very soon. This led to the massive fall in the Dow Jones index.
The Finance Minister of India has introduced a new tax on the profit earned from equities. Ever since this tax was introduced the market started rapidly falling in value. The increase in the interest rate along with the reduced earnings from equities makes market investments considerably less attractive.
For instance, if a war were to be declared between American and China, the effect would be far greater. This is because both these countries make up a major component of the global trade. Also, both these countries are highly dependent upon each other.
War would disrupt this symbiotic relationship leading to business losses. Hence, the stock market collapses in anticipation of such losses.
Instead, this task is now being done by robots preprogrammed with algorithms. The problem is that since robots are machines, they are still prone to errors. As a result, these robots have led to massive selloffs in the past. Once the downfall starts, a self-perpetuating cycle begins, and market crashes occur.
As an investor, it is necessary to ensure that an eye is kept on the above-mentioned parameters. These events do not happen suddenly. Instead, they just appear to happen suddenly when in reality the trouble is brewing for a long time before the bubble finally bursts.
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