Tuesday, August 25, 2015

US Stocks: Set for Crash ?

https://www.google.com/finance?q=INDEXDJX%3A.DJI&ei=gejbVaGBCsycUv-foJgCThe Dow Jones Index lost 3.5% on Monday 24th Aug, after an initial plunge 6.4% in minutes in early trading.  Since the 2015 Mid July peak of around 18,000 it has dropped to 16,000.   That is a 16% drop in about 3 months.   It is possible the peaks of 14,000 in 2008 are fast approaching.

Some of us have been anticipating a stock and bond market crash larger than the one in 2008.  The crash in 2008 was a 54% drop from a peak of around 14,000 in October 2008 to 6,500 in March 2009.

The US govt pumped in free money in the form of low interest rates and Quantitative Easing (QE).  This mechanism pushed up the prices of stocks.   However, in the long run this is not sustainable without a growth in the economy.

It remains to be seen if US Govt can use monetary policy to maintain stock market prices, and hence market capitalization.  The Dow Jones, an index of 30 companies has a market capitalization of 4.25 trillion at around DJI of 18,000.  The S&P which has about 500 companies has a market cap of about 14 trillion.   So a 10% drop is a loss of 400 billion in the Dow Jones and 1.4 trillion in S&P market capitalization.  

So basically the US Govt has to pump in about 2 trillion to prop up the DJI and S&P.  That is assuming retail and hedge funds and the like dont panic and keep selling.   That would be like trying to remove water with a bucket when there is 10 foot hole in a boat, a loosing proposition. Then there are secondary dominoes like Credit Default Swaps and Margin calls. That is a whole different article.

So what are the implications for Sri Lanka
  • At the first, there will be liquidation of assets (stocks)  in Sri Lanka by foreign investors to cover their losses in the US and other stock markets. So expect drop in Colombo Stock Exchange.
  • Possible price increases in agricultural products and machinery.  There are droughts worldwide and ultimately food security is a primary need.
  • Possible that foreign investors may comeback into Sri Lanka because it might be a relative safe haven, specially the agricultural sector.

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