STOCK MARKET CRASHES: WHAT CAUSES THE STOCK MARKET TO CRASH?
The stock market is relatively stable. However, that is not to say that it does not experience some lows in the form of stock market crashes. These are situations where investors experience a sudden drop in stock prices. In such circumstances, it becomes increasingly hard for companies to raise capital as investors shy away from putting in money. People with shares also experience a loss in income as well as principal amounts invested. There are many reasons as to why the stock market could crash, and the main ones are a disastrous political event or an economic downfall. An example of a crash would be the subprime mortgage crisis that took place between 2008-2009. In the previous three decades, there have been several stock market crashes and given that we are on a nine-year bull run, there are chances that it could experience another low. Here are some signs for which you should be on the lookout:
The role of the central bank
The central bank works at regulating the amount of money in an economy, and their actions affect the stock market. There are situations where the government may feel that there is too much money in the market and at such times, they could increase the interest rates. When doing so, they have to look into whether their actions slow down economic growth and whether they could boost inflation. One wrong move could lead to a situation where people would be unwilling to invest in the stock market and would thus lead to a downfall. Read more about the Central Bank over here
Over time, parties with competing interests engage in trade wars which can often cause an imbalance in the stock market. An example would be in the US where the government imposed tariffs on China as well as other trading partners. These countries reacted by imposing trade tariffs on US goods and slowly this began to affect the economy. If more trade tariffs come into play, there is no telling what will happen and the stock market could crash as a result. It is thus essential that players in the industry pay attention to such occurrences.
Did you know that foreign debt could bring the stock market to its knees? Well, here is a peek as to how this can take place. Take an example of Turkey which has been in financial turmoil for a while now. Over time, their currency which goes by the name lira has weakened in comparison to the dollar. What's more, they owe a debt accounted for in the tune of dollars, and it is becoming harder for them to meet their financial obligations. Other nations such as Spain, Italy, and Greece, also face problems due to liabilities. Over time, the debt status of such countries will affect the stock market, and if the situation goes unchecked, it could lead to a crash.
There are situations where banks come up with regulations that favor them and put investors at risk of losing money. An example would be a regulation that led to a decline in the value of shares while increasing the interest rate on loans. People would have a hard time paying off loans owing to the little income they derive from securities, and this would in turn trigger a stock market crash.
A decline in GDP growth
The growth of the economy affects the stock market and the reverse also holds true. As such, should economic growth decline, there will be results such as an increase in inflation and unemployment which can usher in a stock market crash.
Change in loans
The loaning system works such that a bank will offer you a loan based on your credit score. If you have an excellent rating, then you qualify for high amounts at low interests. For people with a tainted record, banks offer limited loans at very high-interest rates. While this works, it could also affect the economy. Take a situation where the economy is not doing so well, and people start losing their jobs. People owing banks money would have to choose between meeting their needs and those of financial institutions and they would choose the former. Given that these loans are securities; their fall in value would result in a crash in the market.
All players in the stock market should take note of how their activities affect it, and in this way, we can steer clear of future crashes.
Do you want to learn more about the stock market? Read our article on the history of the stock market.