The Reasons Behind the Recent Stock Market Carnage

 

All 3 major stock market indices concurred on Wednesday last, painting a picture of stock market carnage which saw the significant plummeting of each index. The Dow Jones Industrial Average lost approximately 1400 points in a mere 48 hours, while the Nasdaq fell below its 200-day moving average, its worst performance since Brexit in 2016. The S&P 500 suffered a similar fate, recording its worse performance in the last month. But what caused this? What was the reason for this type of carnage in the stock markets?

 

Higher Interest Rates Ahead

The reasons for last Wednesday’s unsettling stock market performance are many but are a reflection of what is happening, and what is expected to happen in the wider economy. One of the most obvious reasons for the carnage is rising interest rates. When interest rates rise, it means that borrowing will become more expensive.

Therefore, companies and organizations that rely on borrowed funds to run their operations, are likely to feel the pinch of rising interest rates where it hurts most – in the bottom line. This will no doubt cut into profit margins, reducing the affected companies’ ability to offer increased or steady dividends to investors and shareholders. Higher interest rates also mean that labor costs are likely to increase, which again will have a negative impact on an organization’s profits.

While rising interest rates negatively affect stock market investors, it is good news for bond investors who can look forward to higher investment returns. In fact, 10-year government bonds reached just a few inches away from a 7-year peak on Wednesday. The bad news for stock market investors is that not only will dividends be affected, but stock prices are also expected to be negatively affected by falling company profits due to increasing costs.

The truth is that we are currently in a period of rising interest rates and investors are reacting to this reality by selling their equity investments. It is in an effort to mitigate potential losses that are likely to occur if interest rates continue in an upward direction.

 

The Impact of Large Cap Stock Prices on the Stock Market

Large cap stock prices have a tremendous impact on the movement of the stock market indices. This is because these large cap stocks account for a large percentage of the entire stock market capitalization and even a slight drop in price of any of these stocks, will have a huge negative impact on the stock market. Stocks such as Facebook, Amazon, Netflix and Google (FANG) have great influence over the general direction of the stock market simply because of their sheer capitalization compared to other medium or small capped companies.

On Wednesday, both Amazon and Netflix stocks fell significantly, sending ripple effects throughout the entire stock market. Netflix stock prices were down by more than 8% while Amazon stock prices were down by over 6%. No doubt, those negative movements were reflected in the stock market indices.

 

Investor Behavior

It is natural for stock market investors to react based on their expectations of the future. This is what triggers sell offs and indeed, this is what triggered last Wednesday’s equity sell off. Investors expect rising interest rates to negatively affect stocks and made moves to sell off any potential losers in order to mitigate losses. At the same time, investors tend to reallocate their investment dollars to assets which attract higher or more stable returns during periods of uncertainty or economic volatility.

Some analysts believe that stock market investors generally opt for value stocks over growth stocks during periods of rising interest rates. This explanation could justify why many investors sought to get rid of large cap growth stocks such as Amazon and Facebook stocks in favor of smaller value stocks.

There are some investors also, who agree with President Donald Trump’s sentiments that the Federal government’s policies are not beneficial to the economy. These investors have therefore opted to invest in areas that are not as heavily impacted by monetary policies.

 

Conclusion

Last Wednesday’s stock market carnage was the result of a number of factors including rising interest rates due to monetary policies, investor expectations and behavior, as well as the disproportionate impact of FANG stock prices on the general stock markets.

 


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