Stock Market Volatility – What does the Dow Jones Drop indicate?

What does the drop in the Dow Jones mean to me?

“When America sneezes, the whole world catches a cold” a quote that’s likely to be regularly used and adapted over the coming days, weeks and maybe months, as the after effects of the recent Dow Jones stock market crash continues to shake stock markets the world over.

As the US stock markets plunged, the Asian markets followed suit, swiftly followed in succession by European stock markets.

Why did the stock market crash?

Uncertainty and risk aversion can often be the driving force behind stock trading decisions. Even the hint at something happening which might affect something else can cause those managing shares linked to that something else to start to balance the risks of staying invested against the likelihood of share value in that thing declining.

If enough investors start to pull their money out of that thing, then the value of that thing starts to decline, meaning that those who took the decision to stay invested see the value of what they have decline also. Do they stay invested in the hope the value returns or get rid as fast as they can to limit their losses?

So what caused the uncertainty in the first place? It seems that the current era of ultra low interest rates is predicted to be coming to an end and inflation to be increasing. The sale of shares, therefore, is based on the fears that some companies, who rely heavily on credit to operate, might struggle to survive if borrowing starts to become more expensive and the things they buy to start costing more. The offloading of shares in those companies while they’re still worth something, has begun the domino effect of sudden sales, causing values to decline, prompting more sales, causing even more declines and so on. It should also be remembered that a significant number of share sales are decided o by computer algorithms that are programmed to react in certain ways without any input from a human being.

Why does the value of American companies affect the UK?

There is a complex relationship between stock prices and exchange rates. The value of the US$ has already taken a small hit on the back of the stock market tumble.

Most financial transactions within the UK are completed using our own UK£ and although many businesses and even retailers might accept Euros in payment, there aren’t many Dollar bills being used to buy things.

Having said that, when using online services, particularly when transacting with American companies, you may well have found prices displayed in Dollars and the price you pay in UK£ fluctuating based on the exchange rate.

The US$ is used as a secondary or even primary currency by many non-American countries around the world and is widely accepted elsewhere, so in these places, the value of the US$ is a much more pressing concern.

The short term effects on the UK are therefore likely to be less severe than in some other parts of the world, but it’s unlikely we’ll be shielded entirely. This is mostly due to the global nature of modern trading.

If American companies shore up their reserves, decrease their investments and cut their spending, that has knock on effects to the foreign companies they invest in and buy from. These companies will in turn have to assess their own cashflow accordingly which naturally affects their own chain of supply and demand. It’s easy to see that in the spider’s web of international trade, no single strand is entirely unaffected by vibrations elsewhere.

So what can I do?

In the short term, assessing your business’s supply chain for potential issues which might affect the way your business operates is a good place to start. Consider what would happen if your usual customers cut back on their buying, or stopped buying completely. What if your suppliers became unable to supply or left the market entirely. There’s never a bad time to consider ‘what if’ scenarios, to look for vulnerabilities in your supply chain or in your cashflow and put in place contingencies for if the worst should happen.

If you need advice on dealing with the fallout from this or other circumstances, however, they might affect you or your business, then don’t be afraid to ask for help. As with all aspects of business and personal finance, the sooner you identify a problem and seek help to rectify it, the easier things are likely to be.

Get in touch with us for a free consultation and we can assess your vulnerabilities and help set you on the right path to mitigating them.

Speak to us, we can help.