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Please be aware that this article was written on 7th February 2018

In the first week of January, the BBC published an article in its business pages: ‘Stock markets hit record highs – here are three reasons why.’ World stock markets did indeed hit record highs in January – and then at the beginning of February, world markets fell dramatically. Was it the beginning of a global downturn? Should investors sell everything and head for the hills? In this special article for our clients, we take a look at what happened, why it happened and what the lessons might be for the future.

What happened in January?

Simply put, world stock markets enjoyed a very good month, with some markets recording gains in the month that would have been more than acceptable for a full year: records were broken everywhere…

Having finished 2017 at 7,688, the FTSE-100 index of leading shares reached an all-time high of 7,779 on January 12th. And the joy wasn’t confined to the UK: stock markets around the world were rising, as they followed a very good 2017 with a stellar start to the New Year. The Hong Kong market rose 10% in the month: Brazil did even better, rising by 11%. India was up, China was up and America’s Dow Jones index broke through the 25,000 barrier for the first time, as it rose 6% to finish January at 26,149.

Why did global stock markets do so well in January?

First and foremost, there was good news from China – the driver of so much of the world’s economy. Growth for 2017 was reported to be 6.9%, well ahead of the Government’s official target of 6.5%. In addition, the World Bank issued a bullish forecast as it looked ahead to 2018. Reporting that global economic growth had been stronger than expected in 2017, the Bank forecast growth of 3.1% for the coming year. The Bank’s president, Jim Yong Kim, said, “The broad-based recovery in global growth is encouraging.”

Factor in low interest rates, easy monetary policy around the world and Donald Trump’s determination to make the American economy great again, and it was no wonder that stock markets were doing well.

In fact, only one major stock market fell during January – the UK. Having reached that all time high in mid-month, the FTSE gradually fell away and finished January down 2% at 7,534 as Government contractor Carillion collapsed and worries continued about Brexit.

A very different story in February

However, by the beginning of the first full week in February – just four weeks on from the BBC’s optimistic story – the headlines were very different:

‘Wall Street suffers sharpest drop since June 2016’

‘Asia stocks join global stock plunge’

City AM joined in with, ‘FTSE follows Asia and Wall Street in third day of global equity rout,’ as the UK’s leading index lost 3.5% of its value as soon as trading started on the morning of Tuesday February 6th.

It is easy to think, ‘So what? The hedge fund millionaires who made so much out of betting against Carillion have just lost some of it.’ But, of course, falls in the stock market affect most of us – the majority of people in the UK (including virtually all who work in the private sector) will have some of their pension and/or savings invested in stock markets, both here and overseas.

Why did stock markets suddenly fall?

Essentially, because of fears over inflation and interest rate rises. Generally speaking, central banks believe that an inflation rate of between 2% and 3% per year is good for developed economies.

The worries started when official figures showed that average wage rises in the US had reached 2.9%, prompting fears that prices would soon start to rise, meaning higher interest rates would be needed to keep a lid on inflation. The US central bank has ‘scheduled’ three 0.25% interest rate rises for this year, but some experts are predicting that could rise to four or five rate increases.

The President’s economic policy plans to inject more than $1tn (£710bn) into the US economy thanks to corporation tax cuts, and many companies have pledged to give their workers pay rises as a result. Hence the need for rate rises to curb inflation and cue many investors taking flight at the prospect of the era of cheap money coming to an end. Ironically, the President’s moves to strengthen the US economy could lead to continuing stock market jitters.

First the US, then the rest of the world…

Falls in the US were quickly followed by falling markets around the world: why did that happen?

Many countries – especially in the developing world – have borrowed heavily in dollars, meaning that rising rates in the US will make servicing that debt more expensive. A booming US economy will suck in imports from those countries, increasing their incomes – but that won’t be good news for Europe. The Eurozone looks unlikely to increase rates in the short term: if the euro then rises against the dollar it will make it harder for European countries to export to the US. Add in the fact that the world is now a very inter-connected place (at least as far as stock markets go) and you have the recipe for the worldwide falls that we saw at the start of the week.

Is it the beginning of a global crash?

In addition to the fall in stock markets, the crypto currency Bitcoin was also tumbling rapidly – falling around 11% in one day to touch $6,000 on Tuesday. That was the lowest level since last November and well off the recent highs of $20,000 as more banks stopped customers buying Bitcoin on their credit cards and the currency came under increased regulatory scrutiny.

With all this turmoil going on, it was easy to believe that stock markets and financial markets around the world were heading for another crash: that we would shortly wake up to more ‘Black Wednesday (or Thursday or Friday) turmoil as markets crash worldwide’ headlines.

It is always the bad days that make the news

Many people reading this will remember ‘Black Monday’ in October 1987 when stock markets around the world crashed: the US Dow Jones index lost more than 20% of its value as it recorded its biggest ever fall in a single day. Going even further back in time, ‘Black Thursday’ was the day that marked the start of the Wall Street Crash and a worldwide recession: that day the US index fell by more than 12%.

As we wrote above, we also need to remember that last year was a particularly good one for world stock markets: the UK was up by 8%, Germany rose 13%, the US market rose 25% and Hong Kong had a spectacular gain of 36% in 2017. There was bound to be a slight correction and/or some profit taking at some point.

It is a cliché, but saving and investing is a marathon, not a sprint. Like so many other things in life, you are in it for the long term. So while fluctuations like those we saw this week make the headlines, you should always look at the long term. ‘Stock market quietly rises 30 points’ will never be headline news…

Hopefully the commentary above has answered some of the questions you may have had about this week’s events – but, as always, don’t hesitate to come back to us if you would like any more information, or if you would like to discuss your savings and investments in more detail. We are never more than a phone call or an email away.

The value of your investment may go down as well as up and you may not get back what you initially invested.

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