Oran Hall The good and bad of a weak stock market
Weak stock markets are characterised by declining trading volumes and stock prices. Although they tend to reduce the wealth of individuals and institutions temporarily, they also provide opportunities for the bold to increase their wealth.
Many wonder why Jamaica’s stock market has fallen from the best-performing in the world a few years ago to one of the worst-performing. It seems to me that, among other reasons, our bull markets tend to be so strong, our bear markets tend to be extreme when the sentiments of investors change.
Markets do not move in just one direction, so stock markets, like other markets, rise and fall, giving us bull markets and bear markets. Markets are driven by expectations as action is taken in anticipation of the consequences of various developments or expected developments. Positive expectations tend to cause stock prices to rise. Conversely, negative expectations tend to cause them to fall. Expectations may or may not be grounded in fact, but they do influence markets.
The factors that influence markets may be internal or external to the local economy. When local interest rates increase, for example, stock prices are likely to fall as investors move their funds away from stocks to interest-earning assets to reap relatively better returns. The opposite tends to happen when interest rates decline.
Local interest rates may also increase when they increase in other countries. For example, our central bank may choose to take action to cause interest rates to increase when they increase in the US to deter the movement of funds into US dollar-denominated instruments to get better returns. In such a case, increasing the demand for the US dollar may cause the value of the Jamaican dollar to fall.
Changes in local taxes, whether by them being increased or reduced or new ones being introduced or existing ones being withdrawn can also affect the stock market to the extent that they affect the costs of businesses and the purchasing power of consumers and thus demand for goods and services and the profits of businesses. Inevitably, the prices of the shares of companies listed on the stock exchange are affected.
Political situations also affect the stock market. For example, expected changes in the political leadership of a country can positively or negatively affect it, depending on whether market participants expect a government to have a positive effect on the economy. Further, how stable the current political situation is can also affect the economy and stock market.
Natural disasters can affect a country and do harm to the economy and stock market. The same is true of health crises like COVID-19 due to the disruptions that they cause to people’s lives and the profits of businesses.
Wars – even those in which we are not involved – can affect our economy, considering that they can affect the flow of trade, the prices of commodities and even inflation. The war between Russia and Ukraine is a cogent example.
Even though Jamaica is an island geographically, economically we are not an island; what happens in the world affects us and our stock market.
When stock prices decline, the value of investors’ portfolios also declines. This may affect their ability to borrow against the value of their portfolio. It may also restrict their ability to sell to generate funds to carry out important plans at the time previously determined.
A weak stock market also affects pension portfolios which include equities. People retiring during the market downturn are at risk of their pensions being adversely affected, especially if they are members of defined contribution retirement arrangements. But the other pension fund members need not have the same experience, as the market eventually recovers, and pension funds are long-term.
People who own equity-linked insurance policies face a similar situation but should not be adversely affected to the extent that they do not need to access their policies for living benefits. Where the payment of death benefits is concerned in such market conditions, beneficiaries would be at a disadvantage.
Investors in mutual funds and unit trusts that invest in equities to any degree are exposed to the value of their investment declining, but they should not be affected if they have no need to liquidate any part of their investment during the downturn.
Stock prices recover sooner or later, so individuals who are not fixated on short-term gain ought not to be seriously disturbed when the market declines, even for a protracted time.
On the upside, weak markets present good buying opportunities; many stocks tend to be undervalued, including those in companies with strong fundamentals. Because no one knows how deep the decline of the stock market will go, the best approach is to buy selectively in a measured way.
Nonetheless, investing at the relatively low prices characteristic of a bear market reduces downside risk, provides opportunities to get significant returns when the market recovers and creates the opportunity to realise relatively better dividend returns based on lower stock prices.
Ultimately, effective investing requires a strategy which includes diversification. While not a vaccination against the negative effects of the inevitable bear market, it does offer some protection.
Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com