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Stock market crash or healthy correction?

Feb 06 2018 21:00

Paris - The dramatic fall in stock prices on Wall Street that has spooked equity markets around the world on Tuesday is making investors nervous that this could be the start of a new stock market crash.

But the underlying strength of the global economy seems to suggest that the sell-off might actually be just a temporary - but long overdue - correction to a more or less uninterrupted market rally since Donald Trump was elected US President in late 2016.

On Monday, New York's Dow Jones Industrial Average saw its steepest ever one-day point drop, shedding a total of 1 175.20 points or a hefty 4.6% in value.

That has triggered panic in Asia and Europe, where stock prices fell sharply on Tuesday.

"We haven't seen swings of such magnitude for a long time and in that sense, it's traumatic," said Jean-Francois Robin, bond strategist at Natixis.

"Lots of investors have become unaccustomed to so-called 'bear' markets."

The downturn began on Friday when bright US non-farm payrolls data sparked fears that inflation will surge this year - and that the Federal Reserve will be forced to raise borrowing costs more quickly than anticipated.

At the same time, US Treasury yields shot to four-year peaks, as bonds become more attractive for investors than stocks.

Behind all this were concerns that central banks could start to wind down their ultra-expansive monetary policy measures more quickly than anticipated.

"Protected by central banks' generosity, investors have got used to low borrowing lates, low inflation and an absence of volatility," said Jean-Louis Mourier, economist at Aurel BGC.

'Herd instinct' 

The current configuration of the market tends to "favour the herd instinct which can partly explains the ferocity of the sell-off", said Robin at Natixis.

But optimism still holds the upper hand, at least for now.

"We can say it's a correction, but I don't believe we're witnessing large-scale panic," said Jean-Laurent Bonnafe, head of BNP Paribas at the bank's annual news conference.

For many analysts, the current bout of selling fever is primarily a matter of "market psychology", said Christopher Dembik, chief economist at Saxo Banque.

But it is the scale of the current sell-off that is putting investors on edge and because of this, what happens over the next few trading sessions will prove crucial.

"Markets sometimes have a tendency to create their own reality," said Vincent Juvyns, strategist at JPMorgan AM.

The pick-up in inflation and the rise in bond yields were already making investors jumpy and so the US jobs data on Friday could have just been a convenient excuse to start selling, he said.

"Objectively, the conditions are not in place for a real crash," Juvyns said. "From an economic point of view, nothing has changed. On the contrary, the latest indicators confirm that the global economy remains robust."

'Healthy correction' 

Robin at Natixis said that markets "are still traumatised by the events of 2008, the worst financial crisis since the 1930s".

"But we're not in 2008," he said.

"There is no reason to panic. Corporate earnings are on the up. Business indices are at their highest levels in decades."

At the current juncture, a stock market correction is "actually rather healthy", Robin argued.

That view is shared by many market players, with the US S&P 500 in January putting in its best start to the year since 1997.

Mourier at Aurel BGC suggested that investors "are finding out that assets regarded as risky, such as shares, are just that".

Investors were being reminded that "inflation and volatility haven't disappeared and central banks won't always be there" as a backstop, added Robin.

Nevertheless, the current correction "offers new opportunities", the expert said.

"The shares in the (French) CAC 40 index, for example, aren't expensive, particularly in view of the outlook for corporate earnings and economic growth. It's actually more of an opportunity to buy shares," Robin concluded.

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