Over the last week, the stock market has gone down significantly. The FTSE 100 has fallen by 6%, and the FTSE 250 is down 5%.
There are two main reasons the stock market has been falling this week. One is rising interest rates but the other big catalyst is a potential crisis in the banking sector.
Why is it happening?
Rising interest rates have been a headwind for share prices for some time now. In a bid to bring down inflation, the Bank of England has increased interest rates from 0.1% in December 2021 to 4% today.
This has allowed investors to get a better return by keeping their money in cash. As a result, share prices have come down to justify the risks associated with owning shares compared to cash or bonds.
That has been weighing on share prices for some time. But the real pressure on the FTSE 100 in recent days has come from a US bank failing after a fall in the value of its assets left it unable to meet its liquidity requirements.
On both sides of the Atlantic, this has resulted in an uncertain banking sector and a volatile stock market. Share prices fell as investors grew concerned that other banks might face similar problems.
The implications of bank failures aren’t limited to the banking sector. They affect other businesses that use credit from banks to fund their growth and their operations.
That’s why share prices have been falling across the board this week. Uncertainty around the banking sector has caused investors to look for safety in assets like gold and bonds.
When will the stock market recover?
The decline in share prices is the result of two things. So it makes sense (to me anyway) that the stock market will recover when those two causes subside.
One of them could be relatively swift. The uncertainty around the banking sector is – in my view – likely to be over fairly soon.
Hedge fund manager Michael Burry tweeted earlier this week that he thought that actions from the US government to protect customers of the failed bank would stop the panic quickly and avoid a liquidity crisis. I agree.
As a result, I think that share prices, especially bank shares, will see some form of speedy recovery. The broader issue of interest rates I expect to take longer and it’s harder to predict.
Central banks in the UK and the US appear to be determined to do what it takes to bring inflation below 2%. That likely involves further interest rate raises.
By itself, this is likely to be a headwind for a potential a stock market recovery. And it increases the risk of a recession, which would also likely weigh on share prices.
Buying shares
The banking crisis over the last week makes it easy to forget that share prices were already under pressure from rising interest rates and high inflation. But those factors are still there.
That’s why I think that the stock market is likely to see a recovery of a sort in the near future. But the medium term is much less easy to predict. As a result, I’m following Warren Buffett’s example. The Berkshire Hathaway CEO has been adding to his investments with prices falling and I’m looking to do likewise.
