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Stock Market Correction Inevitable as Markets Continue to Soar?

Stock Market

The London Stock Exchange opens this week on the back of a Friday closing level that set yet another record high. The Bank of England raising interest rates for the first time in ten years boosted the financial sector. Ordinarily, this might have been expected to be counterbalanced by other sectors such as utilities, telecoms and house builders, for whom higher interest rates are a problem. However, a drop in the pound after the BoE suggested further rate hikes would be slow and gradual, which seemed somewhat at odds with previous guidance, again seems to have been the catalyst for buying.

Over in the U.S., stock markets have reached levels only seen twice before – immediately prior to the dotcom crash in 2000 and Black Tuesday, the legendary Wall Street crash of 1929. That’s based on the ‘Shiller CAPE ratio’, which measures the cyclically adjusted price-to-earnings balance between the share price and how much money companies are making.

There is no guarantee those investing online in the UK are about to see a similar crash but the fact that the two previous times markets hit these heights damagingly steep falls followed is being seen as holding the worrying potential for correlation. The bloated prices of both UK and U.S.-based equity investments, and many European indices also close to record highs, mean that stock markets are currently particularly vulnerable to any shock.

Quoted in The Telegraph, Graham Hacche, from the National Institute for Economic and Social Research (NIESR), Britain’s oldest independent economic research institute and think-tank, believes that any one of a wide range of factors could now result in a sharp correction. He believes policy makers on both sides of the Atlantic are now walking a tight-rope when it comes to interest rate rises. Too fast and we could see a crash and too slow and the bubble could continue to expand at pace, leading to a worse crash when it subsequently then inevitably pops. Geo-political factors such as the Eurozone suddenly changing direction and tightening monetary policy or problems in China’s debt markets could also prove to be the first domino to fall.

Analysts from the likes of BNP Paribas and HSBC have also made comments supporting Hacche’s stance that the current level of investment markets in the UK and U.S. means anything that significantly disrupts the delicate balance supporting them could quickly mean a change in market sentiment.

Options Available to Those Investing Online?
When markets reach such heights it becomes tricky for investors to assess the risk to reward ratio. On the one hand, gains can be at their strongest level towards the end of a bull run and getting out too early can result in missing out. However, getting out too late could see gains very quickly erased.

Investors that don’t intend to cash in on their investments within the next decade will probably be able to ride out any sharp correction. However, increasing cash allocation within the portfolio would provide fire power to take advantage of any sharp drop by then being able to buy cheaply. Starting to adjust a portfolio to a more defensive structure and increasing cash reserves might be a good idea.

Investors approaching retirement and therefore keen to avoid their portfolio losing significant cash value now in the event of a major correction might want to consider taking more drastic action. Significantly increasing cash allocation and allocation to more defensive asset classes such as bonds is worth considering. Seeking professional, qualified advice is a good idea, particularly for those plan to start actively taking an income from their investments in the nearer future.

Risk Warning:

Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.

There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.

Paul

The author Paul