MARKET COMMENT
Why The Stock Market Is Falling - Part Two

By Bruce Jackson (TMFGoogly)
June 21, 2002

As of writing, the relentless fall in the stock market continues unabated. Part one of this two part series dealt with the main reason for the fall -- that we're still running off the excesses of yesteryear. There are three other reasons as to why we're staring a third down year in a row in the face. Here goes.

Reason 2 - The Terrorist Threat

Stock markets hate uncertainty. They particularly hate war, not surprisingly. I'm not a big fan of it either. The terrorist threat is not going to go away anytime soon. We've been living with it for many years now. It's just that September 11th raised that threat to previously unseen levels.

Whatever the political rights or wrongs of the messy Israel / Palestine war, the bottom line is that the USA, the one global superpower and the biggest economy in the world, are the number one target for the terrorists. They will strike again, and they will strike again in a big way. Billionaire investor Warren Buffett goes as far as to say there almost certainly will be a nuclear strike on the US in the future.

"We're going to have something in the way of a major nuclear event in this (USA) country," said Buffett in May this year. "It will happen. Whether it will happen in 10 years or 10 minutes, or 50 years ... it's virtually a certainty."

A nuclear attack is an awful prospect. Any attack is an awful prospect. The effects of such an attack on the world economy are unknown, but one thing is for sure, they won't be positive. The bottom line is that another reason why the stock market is falling because it fears another major terrorist strike.

Reason 3 - The Spectre Of Higher UK Interest Rates

Last week, the Bank of England warned that the growth in prices for houses was unsustainable. Governor Eddie George told a Commons committee that "We have got to be clear that if consumer growth continues at its recent rate, driven in part by house prices, we would have to act to moderate that. I think this is as clear a signal as I can give."

That clear signal refers to interest rates. In order to moderate the housing market, interest rates would need to rise. The spectre of rising interest rates is generally seen as bad for the stock market, and rightly so. If today you can receive a 4% risk-free interest rate and tomorrow you can suddenly receive a 5% risk-free interest rate, all things else being equal, the amount you'd be prepared to pay for non-risk-free shares has to be lower.

The stock market is falling because it expects higher interest rates in the not too distant future.

Reason 4 - Accounting Concerns

Accounting concerns are sometimes referred to as Enronitis. During the great bull market of the late 1990s, few investors bothered to look in detail into a company's accounts. They trusted the company and the company's auditors, to produce a true and fair set of accounts, and that was that.

By far the vast majority of companies do produce a true and fair set of accounts. But, there are always a few bad eggs out there, usually fuelled by a heady combination of fear and greed, as we saw from the Enron debacle.

Periodically, companies will come under the Enron microscope. Doubts will surface about the validity of their accounts, and their shares will fall, as will those of companies in similar industries. End result? A nervous and falling stock market.

Bonus Reason - Fear

People are scared. They see their investments falling day after day, month after month and now year after year. In some cases, portfolios built up over many years have been decimated. Bear a thought for those poor pensioners who invested in the old GEC many years ago, only to see the managers of that once solid company blow everything will an ill conceived diversification into the telecom sector. Today GEC is called Marconi (LSE: MONI) and its share price is under 5p. 

Fearful of their portfolios going even lower, some people have bailed out of the stock market all together. They can't stand any more pain. Their selling drives the market lower.

What To Do Now

Now you know the reasons for the falling market, the big question becomes "so what does it mean to me now?". As it just so happens, we have an article entitled "What To Do In A Falling Market". It was written not long after the September 11 atrocities, but remains just as relevant today. Happy investing.

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