What's Behind the Stock Market Plunge
Is this the start of a so-called correction?Not yet, but it's certainly possible. Technically, a market correction is defined as a 10 percent decline in stock prices. Yet yesterday's sell-off only shaved about 3 percent off the market's value. The truth is, the U.S. stock market hasn't seen a real correction since the bear market ended in October 2002–which means eventually we're due for one.
Is this the start of another bear market?
It's way too soon to be thinking bear market. Bear markets are officially defined as a sustained 20 percent drop in equity prices. And we're nowhere near that. To be sure, "today's market action has no doubt left many asking, 'Is this the beginning of the end?' says Tim Swanson, chief investment officer for the National City Private Client Group. "The short answer is we don't think so," he says.
So what's the significance of yesterday's market slide?
It serves as "an important reminder that volatility won't stay low forever," Swanson says. "After a very long period of low volatility, it is easy to get lulled into a false sense of security. Investors need to remember that in order to earn attractive rates of return, you must be willing to accept risk." And the downside of risk is the probability of actually losing some money in the stock market.
Why did investors in the United States get spooked about a drop in China's stock market?
Joseph Quinlan, chief market strategist of global wealth and investment management at Bank of America, points out that "China's market downturn comes at a time when U.S. investors have never been more exposed to the emerging markets." He's right. Last year, fund investors did something remarkable: They shoveled more new money into high-risk emerging-markets stock funds–which invest in the emerging economies of Asia (including China), eastern Europe, and Latin America–than they invested in U.S. stock funds, according to Citigroup Investment Research. That's probably because investors love to chase past performance.
China was particularly popular, as U.S. investments in Chinese stocks rose to $5.2 billion, up from $4.9 billion in 2005. "That represents a sea change from prior years," Quinlan says.
Is China in danger of bursting like the late '90s Internet bubble?
Many market strategists don't think so. The reason the Chinese stock market sold off was that government authorities indicated that they would be strengthening securities enforcement and adopting new rules to reduce rampant speculation. While that spooked the markets in the short term, in the long term it could be a positive development.
Regardless of the market reaction, S&P forecasts that China's economy will still expand by about 9.5 percent to 9.9 percent in 2007–which is about three times the growth rate for the U.S. economy.
Bob Doll, global chief investment officer of equities at BlackRock, notes that "the market downturn in China is primarily a local event, and we do not expect that this decline will have a widespread, long-term impact across the globe."
Does this mean investors should no longer consider putting money in the foreign markets?
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