Reasons behind stock market crash

Stock Markets



I want to talk about the economic effects of the virus and the reasons behind the crash of the stock market.



Stock markets are crashing, Central Banks are cutting interest rates and governments around the world are taking accommodating stance. Amidst all this came an unexpected - Russia and Saudi Arabia break-down. (A disagreement about the quantity of oil production and sale, Saudi Arabia announced it’s decision to ramp up production.) Oil prices crashed and already impacted stock markets got into downward frenzy. And after 2013, once again "Circuit breaker" is the happening of the day.



Markets across Asia collapsed, with Australia, Japan, China and Hong Kong taking a big hit. In Europe; London, France and Germany, all the indexes crashed. U.S. stock market is unable to hold the short recoveries that it made and is crashing to the new lows every week.



There is a health crisis which is transcending into a financial one.



Virus and the economy

Factories and retail stores are closing, corporates are working from home and kids are staying home; all this is going to hit the company finances in the short-run and in some cases long-run.



GDP growth, Morgan Stanley forecasts, will dip to an annualized rate of 2.3% before recovering to 3.1% in the following six months, boosted by stimulus from governments and central banks.



Stock Market Coronavirus, which was a country problem till few months back has evolved as the biggest threat to the global economy. There is lot of news, information and MISINFORMATION about Coronavirus; I am not going to add anything of that kind.I want to talk about the economic effects of the virus and the reasons behind the crash of the stock market.Stock markets are crashing, Central Banks are cutting interest rates and governments around the world are taking accommodating stance. Amidst all this came an unexpected - Russia and Saudi Arabia break-down. (A disagreement about the quantity of oil production and sale, Saudi Arabia announced it’s decision to ramp up production.) Oil prices crashed and already impacted stock markets got into downward frenzy. And after 2013, once again "Circuit breaker" is the happening of the day.Markets across Asia collapsed, with Australia, Japan, China and Hong Kong taking a big hit. In Europe; London, France and Germany, all the indexes crashed. U.S. stock market is unable to hold the short recoveries that it made and is crashing to the new lows every week.There is a health crisis which is transcending into a financial one.Factories and retail stores are closing, corporates are working from home and kids are staying home; all this is going to hit the company finances in the short-run and in some cases long-run.GDP growth, Morgan Stanley forecasts, will dip to an annualized rate of 2.3% before recovering to 3.1% in the following six months, boosted by stimulus from governments and central banks. CNN

Monday, March 2, 2020, S&P 500 tanked 11.5% from record highs in the previous week. This massive sell off is triggered by the fear that coronavirus outbreak will negatively impact corporate earnings and profits. This was just the beginning as markets unable to find a stable ground, kept falling after making small recoveries. S&P 500 is down 30% from its peak that it attained less than a month ago.



Rate cut by Central Banks

On March 3, 2020 to calm the market Fed cut the interest rates by half a percentage point As an emergency rate cut. This was Fed’s way of reassuring the market and investors that central bank was taking the threat seriously. But this was not enough to soothe the nerves of the market and economy. Hence, on March 15, Fed dropped the interest rates to zero and announced its buying spree worth $700 billion in the form of government and mortgage-related bonds. This is resurgence of "quantitative easing".



Reserve Bank of Australia cut the rates by a quarter point and dumps $6 billion into the banking system. However, with already negative interest rates, Central Banks of Japan and Europe hardly have any ammunition left to accommodate this crisis.



Manufacturing and Factory Closure

Coronavirus has disrupted manufacturing supply chain as there is hardly a multinational corporation which doesn’t depend on China for either raw material, parts of machines, semi-finished goods or production. On the demand-side China is one of the largest consumer. And with the fall in consumer spending, businesses would falter and stocks would crash.



South Korea, a major producer of cars, electronics and machinery, is the next most effected country after China; followed by Japan and Italy. Collectively these 4 economies represent 27% of Global GDP. And now Germany and U.S. have fallen, rising the risk of global recession.



Closure of non-essential businesses

Movie theater, nightclub, bars are closed to maintain public distancing and restaurants to open only takeaway services. Retail outlets are closed and malls carry an eerie look. Small businesses are required to close.





$19 trillion Corporate Debt

The biggest threat and the Reason behind stock market crash

After 2008 crisis, companies took advantage of the low interest rates to issue bonds and grew their businesses from the cash generated. Corporate debt among non-banks exploded to $75 trillion at the end of 2019, up from $48 trillion at the end of 2009, according to the Institute of International Finance.



With the grimmer economic outlook as mentioned above, there is a general fear that these companies may not be able to make their bond payments. These defaults can throw the already vulnerable markets into self-perpetuating mayhem. Oil crisis has added burden for the energy companies. Travel ban has downgraded airline credit profiles. Sectors like tourism, aviation, energy and oil are bearing direct brunt of falling demand. And due to the fear of default, investors are dumping these companies shares.



Borrowing costs in the short-term leading markets, are rising. Many of he companies borrower billions of dollars on every day basis from this market to fund their daily operations. Commercial paper (a short-term promissory note typically used to take care of expenses like payroll, rent, etc.) market is still tight, even after Fed’s billions of dollar injection into repo market. Now there is a call for Fed to buy short-term corporate debts, something Fed did in 2008. But in that case Fed would be required to use its special lending ability. This would be a kind of 2008 "bailout".



Small businesses are losing money on daily basis and they know, recovery is not going to be anything soon. Unable to borrow, they could be forced to cut operations and may file bankruptcy. And this is increasing the risk of defaults on the mortgage payment to the banks. Hence the banking sector is at indirect risk. After 2008 crisis, companies took advantage of the low interest rates to issue bonds and grew their businesses from the cash generated. Corporate debt among non-banks exploded to $75 trillion at the end of 2019, up from $48 trillion at the end of 2009, according to the Institute of International Finance. CNN With the grimmer economic outlook as mentioned above, there is a general fear thatThese defaults can throw the already vulnerable markets into self-perpetuating mayhem. Oil crisis has added burden for the energy companies. Travel ban has downgraded airline credit profiles. Sectors like tourism, aviation, energy and oil are bearing direct brunt of falling demand. And due to the fear of default, investors are dumping these companies shares.Borrowing costs in the short-term leading markets, are rising. Many of he companies borrower billions of dollars on every day basis from this market to fund their daily operations.(a short-term promissory note typically used to take care of expenses like payroll, rent, etc.)even after Fed’s billions of dollar injection into repo market. Now there is a call for Fed to buy short-term corporate debts, something Fed did in 2008. But in that case Fed would be required to use its special lending ability. This would be a kind of 2008 "bailout".Small businesses are losing money on daily basis and they know, recovery is not going to be anything soon. Unable to borrow, they could be forced to cut operations and may file bankruptcy. And this is increasing the risk of





Corporate ratings are at risk of downgrade, especially for the corporate bonds that are on the lower end of the rating spectrum and any downgrade can turn them into "junk".



According to a stress test conducted by IMF, corporate debt worth $19 trillion from eight countries-China, the United States, Japan, the United Kingdom, France, Spain, Italy and German- is at risk of default. That would be 40% of all corporate debt.



Government is making it easy for the small businesses that employ more than 500 employees, to take direct loans from the Fed through it’s discount window. Till now this facility was open only to the banks. But this kind of cash demand by the companies can drain the entire global financial system.





Corporate bonds being at risk of default increases demand for the safe-haven government bonds, sending prices up and their yields down. As demand for the U.S. government bonds goes up, long-term interest rates fall to historic lows. This would put extra pressure on the banking sector. As banks would put breaks on finances for the businesses which would cut production and may lead to layoffs.



Silver lining

This is not a structural crisis

We are amidst a crisis but this is not a structural crisis. Public health crisis has triggered a spiral movement but this is nothing like pervious global meltdowns.



It’s nothing like the Stock market crash of 1987 known as the "Black Monday" when the Dow Jones index fell by 23%, neither the Asia crisis of 1997 nor the Dotcom bubble of 2000. This is nothing like 2008 where the structural flaws of the banking and financial market, pushed global economies into recession.



Asia-Pacific markets are trying to stabilize after hard landing. Oil prices rose and 10-year U.S. Treasury bond prices fell and yields rose.



Countries like China and South Korea are slowly but steady retuning to the regular activity levels and other economies too would resume once the pandemic is under control. Russia and Saudi Arabia are going to find a new equilibrium and till then low fuel prices are a good news at least to the consumer.



Banks are lowering the interest rates and are ready to finance small businesses that lost their business to lock-down and slowed consumer demand. Government on its part is taking pro-active steps in terms of tax cuts, medi-care, and federal aid to the state governments. Panic buying on the consumers part has created demand which never existed.....(empty selves of grocery stores and long queue in front of Costco are proofs of panic buying).





From a long term investment point....this is time to buy the stocks. Markets are in correction mode around the world. (Stock market correction refers to 10% decline from a recent high. It’s definitely less severe than the bear market i.e. a 20% decline). It might be scary but stocks are not supposed to keep rising and a breather once in a while is needed. In fact this can be seen as an opportunity to buy certain stocks that otherwise seem high priced and expensive.



Markets have recovered in the past and investor resilience will sustain this crisis too.







