Having fallen by as much as 12% from its May 2018 all-time high, the FTSE 100 has experienced a modest recovery in recent trading sessions. The index has gained as much as 3.5% over the last week, with investors seemingly feeling more optimistic about the prospects for the world economy.
However, a number of threats continue to face the FTSE 100. As such, the risk of a stock market crash remains in place, with further volatility potentially being ahead.
The fall in the FTSE 100 seems to have been caused by fears surrounding the prospects for the world economy. The US economy is growing at a stunning rate at the present time, with GDP growth expected to be over 3% for 2018. Unemployment is low, while confidence remains high. As such, it would be natural for the Federal Reserve to continue raising interest rates at a modest pace as it seeks to reduce the potential threat of inflation.
But this could have unintended consequences. It may reduce the rate of growth not only in the US, but also in emerging markets that have taken on high levels of debt since the financial crisis. The cost of servicing that debt looks set to increase, and this could squeeze the growth rate of the developing world, as well as the rest of the global economy.
In tandem with this threat is the continued uncertainty surrounding tariffs. There have been numerous tariffs placed on imports since Donald Trump came to office, and there remains the possibility that further protectionist policies could be ahead. Their effect on world economic growth may not be felt instantly, but over time they have the potential to cause reduced growth rates which could ultimately lead to lower share prices.
Although the FTSE 100 has recovered part of its 12% fall since May in recent days, it could prove to be a temporary respite. The risks which weighed down its performance in recent months have not yet subsided, and could cause investors to panic once again. As such, the index could prove to be volatile over the coming months.
Certainly, a strong recovery could be ahead if the threat of rapidly-rising US interest rates and protectionist policies subsides. However, that remains a known unknown, and investors may wish to remain cautious about the near-term prospects for the index.
Of course, falls in the FTSE 100 could present buying opportunities for long-term investors. A number of high-quality stocks are already trading on appealing valuations, and they may become even more enticing in the short run. For investors who are able to focus on a company’s balance sheet strength, cash flow and resilience during volatile trading conditions, a market crash could prove to be a good thing. They may be able to capitalise on what remains a very fluid situation which appears to still involve a high level of risk.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.