Finance Finance News The bigger risk beyond the stock market slump

The bigger risk beyond the stock market slump

Australian shares ASX correction
Pundits are divided as to whether warning signs in stock markets will develop into a major correction. Photo: Getty
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Stock markets continued to flash red on Monday as investors became increasingly spooked by the prospect of higher global interest rates.

As described last week, a mismatch between the amount governments and corporations want to borrow, and the amount investors are willing to lend, is pushing borrowing costs ever higher.

That, as expected, hit Wall Street shares hard on Friday. This, in turn, led to heavy price falls when Australasian stock exchanges began opening on Monday.

As a snapshot, at 5pm AEST on Monday, Japan’s Nikkei share index was down 2.4 per cent, Hong Kong’s Hang Seng down 1.2 per cent, New Zealand’s index of top 50 companies down 2.1 per cent, and our own index of top 200 shares was off by 1.6 per cent.

Those are hefty falls, and the kind that make the evening news – “$30 billion was wiped off the value of Australian shares today” being the usual form of the story.

That will send waves of anxiety through Australians getting close to retirement age, but for younger Australians is there anything to worry about?

The answer is ‘yes’, but not in the way you might think.

What are stocks for?

There are two ways of looking at the ups and downs of shares traded on stock markets.

The first, which looks a lot like gambling to the untrained eye, is investors trying to maximise their total returns – a combination of capital gains and the dividends paid by the companies whose shares they own.

If Monday’s slump continues, shares bought recently may go far enough ‘underwater’ for the investors to be in the red for a couple of years.

On the other hand, an average basket of shares bought two years ago would have to fall by 20 per cent to be in the red in capital terms, or 36 per cent for the investor to have lost money in nominal terms once dividends had been accounted for.

Financial planners like to tell investors – and most of us are investors through our super – not to worry about these kinds of moves.

“You can’t time the market,” they will tell you, “so just sit tight and wait for it to recover.”

That advice would have helped panicked investors who sold off their shareholdings in the depths of the global financial crisis (GFC).

Those who sold at the bottom of the GFC in March 2009, reasoning that they “couldn’t afford to lose any more”, would have lost 50 per cent of the value of their shares from the peak valuation in 2007.

But those following the advice to sit tight would have seen the 50 per cent loss reduce to just a 30 per cent loss by September of that year – and shares continued to grind higher from there, paying dividends as they went.

The real world

The other way of looking at shares is to consider the economic growth linked to stock market performance, and here there is plenty to fret about.

It’s easy to forget that stock markets originally came into being to raise capital, which companies then ‘risk’ by investing.

When share prices really crash, as happened between 2007 and 2009, capital raising through the share markets becomes much harder.

A company has to issue a lot more shares to raise equity capital, thereby annoying the hell out of existing shareholders by diluting their shareholdings.

In the current environment, the cause of any share price crash is likely to be the rising cost of borrowing on global bond markets.

So we’d be looking at a double-whammy – falling share prices make it harder for companies to raise equity capital, and rising bond yields make it far more expensive to service debt.

The end result would be less investment, and fewer jobs.

And that’s before the ‘wealth effect’ evaporates. When share markets are high, consumers tend to be confident and some enjoy spending the healthy dividends paid by the companies they hold shares in.

When companies struggle to raise capital and to service their debts, their share prices fall further and they often have to cut their dividends too – all of which feeds into lousy consumer confidence and less spending power.

So unless you’re nearing retirement, the real economy effects are far more worrying that what you may, or may not, be worth on paper.

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