Towards the Next Financial Storm

It seems that the storm that raged across global financial markets has already subsided. However, experts warn that another one is on the horizon. What could trigger the next bout of financial panic? The previous storm was sparked by poor economic data from the United States and fears of a significant slowdown. Perhaps that’s why it calmed down relatively quickly—fears, after all, are just fears. But what real and substantial problems are knocking at our door? Could there be more pervasive issues lurking behind the fluctuations in stock prices and market indices?

The August storm began on the second day of the month in response to poor labour market data from the United States. Investors and market speculators are usually highly attuned to such signals. Why are they so attentive to this kind of information? These are early warnings of a potential economic slowdown, and thus, an inevitable decline in stock prices. If investors and traders sense the taste of blood, they start to drive the market down—selling off everything that might drop in value tomorrow or even the day after. Such a sell-off acts as a self-fulfilling prophecy.

When too many market participants believe that stocks will fall tomorrow, they certainly will, as the sell-off triggers an even bigger sell-off. This process can escalate like a wildfire. The most skilled investors sense the danger in advance. This was the case with Warren Buffett’s investment fund, which significantly reduced its holdings of Apple shares just before the market decline. After that, Apple stood no chance of holding its ground for two reasons: a large supply of these shares flooded the market, and smaller investors decided to follow the lead of a guru like Buffett.

Big Swings

On Monday, 5 August, US stock markets closed in the red, with the Nasdaq and S&P 500 indices falling by at least 3% each. This was the result of the sell-off that began the previous weekend due to fears of a recession in the United States. To recap, the three major US stock indices recorded their largest percentage declines over three days in early August since June 2022. The Dow dropped by 2.6%, the S&P 500 by 3%, and the Nasdaq by 3.4%. Some individual stocks fell even more sharply, with Apple losing 4.8% of its value.

However, just a week later, on 12 August, Apple shares were actively trying to recover the losses they had incurred—following a 6.8% drop in the first five days of August, they rebounded by almost 4.8%. Yet, most stock indices have not fully recouped their losses. For example, the Dow fell by 5.2% from 31 July to 5 August, and by the evening of 12 August, it had only regained 1.7%. The S&P 500 index dropped by 5.9% in the first five days of August, and from 5 to 12 August, it recovered 3.9%. Similarly, the Nasdaq fell by 7.9% during the same period and then rebounded by 4.1%.

The key takeaway from the August financial storm is that there wasn’t sufficient reason for excessive panic.

In summary, the various US stock indices behaved in a similar manner—experiencing significant declines from 1 to 5 August, followed by a partial recovery. This is not surprising, as it’s all the same financial market, with the same reasons for panic affecting everyone.

And What About Europe?

The British FTSE 100 stock index closely mirrored its transatlantic counterparts, falling by 4.9% from 31 July to 5 August, and then recovering by 3.3% up to 12 August. The most famous German index, the DAX, dropped by 6.3% from 31 July to 6 August, then rebounded by 2.3%.

This suggests a relatively confident, albeit slow, recovery. However, there are no guarantees that this recovery will continue or that it will compensate for the losses incurred by the markets in the first five days of August.

What conclusions can be drawn from this? First, the most professional investors could have earned between 5% and 12% in the first 12 days of August if they had correctly bet on the decline of indices and then on their recovery. Such a strategy requires a deep understanding of market processes and nerves of steel. It’s likely that most small players suffered losses, while only the big players profited from those losses.

Somewhere Near the End of This Wave

In reality, the recovery stalled on 12 August because its potential, in terms of expectations, was somewhat exhausted. On 14 August, inflation data from the United States is expected, followed by consumer spending figures—specifically, retail sales—on 15 August. The preliminary sentiment is cautiously optimistic, so it doesn’t seem like anyone will be stepping on the accelerator after a brief slowdown.

European markets are still looking across the Atlantic, as fresh data on the European economy is expected closer to the end of August. However, some figures on employment, GDP, and inflation in the Eurozone are due to be released on Wednesday, 14 August.

Meanwhile, there are whispers in the background that "trees don’t grow to the sky." This refers to the fact that over the past 4.5 years, the German DAX index has increased by nearly 50%, the American Dow by almost 36%, and the British FTSE 100 by nearly 10%. These gains are largely a result of aggressive money printing to combat the economic fallout from the COVID-19 pandemic. In the past two years, central banks in developed countries have been trying to atone for the sins of overly enthusiastic use of the printing press.

These stock market gains are not grounded in solid economic growth. On the contrary, 2020 saw a downturn, followed by moderate recovery over the next three years. These results do not justify the double-digit percentage growth in stock markets. So, this discrepancy might burst at some point. Or it might not.

Central banks are currently deeply engaged in the fight against rapid inflation. This year, they are determined to bring it closer to 2% annually. Only then can they start stimulating economic growth, which would provide a healthier foundation for stock and market index growth.

So far, the situation doesn’t seem to pose significant threats to the average European or American. This is far from resembling something like the Great Depression of the 20th century or the global mortgage crisis of 2007-2008. However, there is still cause for concern because the economy isn’t the only factor at play.

For instance, a number of regional wars and conflicts could unexpectedly contribute to global economic instability. Russia’s invasion of Ukraine has already caused shocks in food markets. The threat to Taiwan poses risks to the supply of microelectronics, which is now ubiquitous. Unrest in the Middle East threatens global energy security.

There are significant concerns about the economic consequences of the overly aggressive fight against climate change. The cost of addressing climate problems should not exceed the scale of the threats posed by these problems. Yet, in some cases, this is exactly what happens—additional costs to combat carbon footprints often accelerate inflation and suppress economic growth. Moreover, the production of equipment for electric vehicles sometimes has an excessively large carbon footprint.