The Global Market Sell-Off

Stock markets in recent years have benefitted from very easy monetary policies. There has been quantitative easing from the Federal Reserve (QE I, II and III), The Bank of Japan and more recently the ECB. There have for some time been concerns about the outrageous valuation of shares of certain US companies such as Facebook (FB), Twitter (TWTR), Tesla (TSLA), GoPro (GPRO), Netflix (NFLX) and Amazon (AMZN). Both short and long term interest rates globally have been artificially low for record amounts of time. It has been over a decade since the Federal Reserve last raised interest rates. This unusual period of money printing and record low interest rates has boosted asset prices not just stocks but also property prices in major towns and cities around the globe.

More interestingly the current bull market up until this correction, has been extremely unusual in that it has been one of the longest ever periods recorded (48 months) without a 10% correction in the S&P 500 index. The previous longest periods were october 1990- october 1997 (84 months) and March 2003 till october 2007 (54 months).  See Chart 1 below, Green candles are up for the month red candles are down for the month:

Chart 1 Monthly Movements in the S& P 500 Index

Click on picture to enlarge

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Equities are risky assets and do not go up forever in straight lines, so corrections can be at times be fast and furious. This acts as a useful reminder to investors that stocks are risky assets. Another sign that US stocks had become overvalued was the fact that the price earnings- ratio was approaching 19 to 20 times earnings see Chart 2. Whereas using Professor Shiller’s 10 year cyclically adjusted ratio – see chart 3 - the market is even more overvalued at 24 times 10 year average earnings. Prospective 10 annual returns were likely to be in the region of just 2-3% which is too low to compensate investors to hold risky assets. The recent fall in US and other stock markets will help to improve future stock returns to more like the 3-5% range. 

Chart 2: Price to Earnings Ratio on the S& P 500

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