If you want someone to blame for this recent bout of stock market crazy, blame China. This is what happens when a nation’s stock market doubles in 12 months and you spend the last 10 years building cities that are essentially massive ghost towns.
During the last 12 months, the Chinese stock market more than doubled. That is a historic surge in market value by any measure. Beginning this past June, the Chinese stock market began dropping significantly and returning to more reasonable levels. However, the Chinese government began to intervene with the intent of halting the decline.
6 month chart of the Shanghai Composite (Chinese Stock Market)
Meanwhile, most developed markets around the globe remained orderly. The Chinese government last week announced they would devalue their currency in an attempt to improve their economy by making their goods less expensive in the global market and help boost confidence at home.
None of the efforts by the Chinese government to halt the decline in their stock market have worked. This has left global markets concerned about a slowing Chinese economy and worried about the potential for their problems spreading into other markets.
It is also important to note that our markets have not had a correction in many years. While painful and hard to watch, these “sell offs” occur periodically. U.S. stock markets are down at least 10% from their highs and that means we are officially in a “correction.” Our economy is still not fully healed from the Great Recession, but many economists would argue we are on a much stronger foundation than we were prior to that period. Companies still have record amounts of cash on their balance sheets and p/e ratios that are still within historical ranges.
While it might be a fun exercise to identify what is causing this global stock correction, a more important exercise would be exploring how you will react to it. Stepping back and recognizing that financial markets always have and always will go into these phases, is a good first step. Consider this, from July 21, 2011 through October 3, 2011 the Dow Jones dropped 16% and gained all of it back within three months! Within three years it was up 59%! I’m not suggesting the same will occur this time. No one can predict the future. However, just because things are ugly now does not mean they will stay ugly forever.
3 year chart of the Dow Jones from October 2011 to October 2014
Staying calm in the face of fear is easier said than done but necessary to avoid snap decisions. After all, successful investing involves pain and sacrifice. Right now we’re in the pain phase. While it is impossible to predict the future, we can look to history to help manage expectations. When the fever breaks on this bout of stock market crazy, we’ll probably refer back to it for some perspective when the next one comes along.
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Images courtesy of Yahoo Finance and FreeDigitalPhotos.net