What causes stock market fluctuations?

Ken Little who authored 12 books on investing and personal finance gives the following reasons for the drop in stock prices:  Interest rates, inflation, earnings, oil and energy prices, war and terrorism, crime and fraud and serious domestic political unrest.  With all due respect to Mr. Little, what he pointed out are the symptoms of the disease rather than the disease itself.  The disease which causes the stock market to tumble significantly is recession.  Yes the stock market will fall at the onset of various bad news such as an increase in the interest rates and energy prices, instability of the Euro Banking system and the high jobless rate.  But if these factors do not lead to a recession, the stock market should quickly recover and continue to rise. Sudden market fluctuation is significant for short-term traders but should not be for long term investors because the market always recovers after a recession.  It would be nice if you can predict the highs and lows of the market because you could have made a killing if you had sold in October 2007 when the Dow Jones Industrial Average hit 14,000 and bought again in March 2009 when it plunged to a low of 6,600.  Therefore, the Eurozone problem, high jobless rate, the downgrading of Spanish bonds, North and South Korean conflict, Israeli’s deadly raid and the BP oil spill do not worry me as much as decrease in retail sales, reduction in hiring, declining commodity prices, industrial production and housing starts.  The day-traders may drive down the stock market purely on investor sentiment and emotion, and we may yet see a DJIA of 9,000 in just a few weeks, but it defies logic for a downward trend to continue if all leading economic indicators are pointing upwards.  This is all intricately connected because if stocks do not recover quickly, and we get into a prolonged bear market, consumer confidence may deteriorate resulting in reduced consumer spending.   Again, I do not see a protracted bear market unless we are heading for another recession.

We must go back to basics to enable us to assess where we are now in the economic recovery.  Recessions are a normal part of a business cycle.  Recession comes from the word “recess” which most of us know is the suspension of whatever we are doing in order to have fun and relaxation.  As in “let the children play during recess”.  However, in business lingo recession is a word that is feared by most people because it can be defined as the suspension of consumer spending or to put in milder terms, an intermission from spending.  In economic terms recession is often referred to as a “contraction” of the economy and the recovery which follows is commonly called an economic expansion.  Recession is feared by most people because it results in the reduction of wealth.

Historically, recessions are brief with this last one, dubbed “the great recession” being the most severe since the great depression.  It is the consensus of many economists that this last recession lasted 18 months.  Now that we know recessions are merely temporary suspension of consumer spending, we can be sure that economic growth will follow shortly unless a catastrophic event ensues, such as the collapse of the banking system leading to a depression, another bubble burst or some kind of a natural disaster.  It is the opinion of many economists that “the Great Recession” has not been followed by a “Great Recovery” because taxes and government spending have not been reduced by this administration.  Historically, tax cuts have always spurred economic growth.

But where are we now in the course of this economic expansion after the great recession?  I have a more optimistic outlook and I am hoping that we are halfway back up a “V” shape recovery and not in a “U” shape recovery.  The European Debt Crisis and the high unemployment rate alone should not cause the stock market to plunge. First, the European Debt Crisis has been alleviated by the commitment of the European Union Central Bank and the IMF (International Monetary Fund) to pledge almost $1 trillion in bail out money (Le Tarpe) for ailing Eurozone countries such as Greece, Spain and Portugal.  Le Tarpe has a great potential for success if used judiciously in buying junk bonds of troubled countries but The European Central Bank must continue to demand austerity measures from leaders of these countries.  Although Greece’s default is imminent, Le Tarpe should temper investors’ sentiment since the bail out money should tide Greece over for a year or two.  The stock market plunge this month, the worst May for stocks since 1940 was caused by investors’ panic and uncertainty about Le Tarpe.

Second, the high jobless rate of 10% is not enough to derail the recovery.  Even if the entire unemployed population stops spending, there is still the remaining 90% of the working population, which according to statistics, continues to consume.  If consumer spending is lower than forecast in May, that would worry me and I am sure it would worry stock market investors.  Despite the high jobless rate the private sector is still reporting robust increase in hiring through the end of April.  What would cause the stock market to plunge some more is bad economic news that could signal another recession.  And going back to basics again—what will erode consumer confidence and stop the consumer from spending?  For starters:  Reduction of income; job insecurity; debt increase due to higher interest rates; inflation; diminution of assets, of investments and other tangible property such as real estate.

This article is not intended to provide financial advice.  Please consult your financial advisor before acting on any advice provided herein.

Any opinions and views expressed herein are the sole responsibility of the writer.

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