A reflection on the current stock market fiasco
Last Aug. 5, the S&P downgraded the U.S. credit rating for the first time and thus begun what looks like a roller-coaster ride for the stocks all over the world. When is it going to end, soon or next year? Where, in the bottom or up in the chart? Such questions may not concern us here in Cebu where only very few people own stocks. Owning not a single stock, you are no poorer or richer, whichever the market goes. That is true but what if as a result of the stock market carnage investment and exports stop, you could lose your job or business. That surely hurts.
But how in the world could investment or export stop with the great amount of uncertainty that presently befell the stock market? The answer is this: The movement of stock generally gives a preview of what is going to happen to the economy—how much more or less it will produce or grow and how many will be employed. A falling stock market if sustained for some time can mean trouble ahead in the economy. When the stocks are down, it could discourage investment and limit the ability of the country to create jobs. When it is up, it could be a sign that the economy is booming with plenty of job and business opportunities.
As in the rest of the world, the Philippine stock market managed to recover from its losses in the last global recession. But things were not totally right since the end of the last recession, especially in the US where the unemployment is still high and Europe where many countries ended up with an unsustainable pile of sovereign debts. Slowing US and Euro economies can make smaller and poorer countries, like the Philippines, also suffer from falling trade and investment. This is what concerns us here in Cebu even if we do not own stocks. So it pays for us to be concern or give some attention to what is happening to the stock market.
The global stocks took a dive when the S&P announced its downgrading of the US credit rating one notch lower from AAA, the highest rating given to a financially healthy entity. It recovered immediately when the Federal Reserve, the US equivalent of a central bank, also announced that it would keep its policy rates low for the next two years after seeing that the US economy is not recovering fast enough from the last recession. But since then, the stocks went down and up again depending on which news—good or bad—prevails on the day. Hence, the uncertainty that envelops the global stock market, including the Philippines.
What is next? The answer to this question depends on how stockholders respond to what happens to the market. This is because the market moves only in the direction that buyers and sellers take. They could sell today or in the morning and buy tomorrow or in the afternoon. When the buying and selling is done in great volume, the market gyrates wildly, which creates more uncertainty in turn.
What to do? If you are in the stock market, the best thing to do is to stop buying or selling and let the market settle first. Look for the long-term trend, not the daily cycle. It matters not if the market is down today. Over time it goes up unmistakably. That is also true for the economy. Knowing that, you can just hold on to your portfolio of stocks. If you do not stop and just follow the market, you could end up selling low and buying high most of the times and suffer more losses in the end.
A downgrade in the US credit rating speaks volume of the financial health of the US government, especially with respect to its ability to pay its loans. A financially crippled government also means that its ability to prop up the economy when needed is questionable. But wait, why did downgrading of the US credit rating lead to a carnage in the stock market?
We can see that instead of dumping, as it usually happened to many countries with downgraded credit ratings, many investors continued to park their money in US government treasuries or bonds, no matter how low the yield. What was punished by the S&P downgrading of the US government credit rating was not the US government but the stock market where much of the world’s savings are also placed. It is as if what the S&P actually downgraded was the credit ratings of all the listed companies in the stock market, not the credit rating of the US government. Did not the S&P make a big mistake here?
What about the economy? Is it not affected by the roller-coaster ride that we are seeing now in the stock market? My answer is that in the short run, production and employment does not change abruptly in the aggregate with the changes in the stock market. In fact, in the short run, it is the stock market that responds more to the changes in the economy. You report that the economy is moving up, the stock market will respond positively immediately. You report that the economy is heading down, the stock market also goes down.
The problem is that the stock market also goes up and down for many other reasons than the reported short-term movements in the economy. You report that another oil-producing country is in trouble politically and one can bet that the global stocks will also be in trouble. You report that a good leader is elected in the highest position of the country and you will also see the country’s stock market soaring.
This is why, in my economic briefing to the members of the Rotary Club of West-Cebu, I told them that if you invest in stocks, it should be for the long term and that looking at the stock market news in the morning could only increase your blood pressure. So much for the stock market.
