With the onset of the pandemic in early 2020, stock markets around the world fell dramatically, with many indices falling by 30% or more. In the USA, the Dow Jones fell by 37% and the Nasdaq fell by 30%. In the UK, the FTSE 100 fell by 33% and the FTSE 250 by 41%.
But with a combination of large-scale government support for their economies, quantitative easing by central banks and returning confidence of investors, stock markets then made a sustained recovery and have continued to grow strongly since – until recently, that is.
With inflation well above target levels, central banks have ended quantitative easing (QE) or have indicated that they soon will. Interest rates are set to rise, if only slowly. The Bank of England raised Bank Rate from its historic low of 0.1% to 0.25% on 16 December 2021 and ceased QE, having reached its target of £895 billion of asset purchases. On 4 February 2022, it raised Bank Rate to 0.5%. The Fed has announced that it will gradually raise interest rates and will end QE in March 2022, and later in the year could begin selling some of the assets it has purchased (quantitative tightening). The ECB is not ending QE or raising interest rates for the time being, but is likely to do so later in the year.
At the same time economic growth is slowing, leading to fears of stagflation. Governments are likely to dampen growth further by tightening fiscal policy. In the UK, national insurance is set to rise by 1.25 percentage points in April.
The slowdown in growth may discourage central banks from tightening monetary policy more than very slightly. Indeed, in the light of its slowing economy, the Chinese central bank cut interest rates on 20 January 2022. Nevertheless, it is likely that the global trend will be towards tighter monetary policy.
The fears of slowing growth and tighter monetary and fiscal policy have led many stock market investors to predict an end to the rise in stock market prices – an end to the ‘bull run’. This belief was reinforced by growing tensions between Russia and NATO countries and fears (later proved right) that Russia might invade Ukraine with all the turmoil in the global economy that this would entail. Stock market prices have thus fallen.
The key question is what will investors believe. If they believe that share prices will continue to fall they are likely to sell. This has happened since early January, especially in the USA and especially with stocks in the high-tech sector – such stocks being heavily represented in the Nasdaq composite, a broad-based index that includes over 2500 of the equities listed on the Nasdaq stock exchange. From 3 January to 18 February the index fell from 15 833 to 13 548, a fall of 14.4%. But will this fall be seen as enough to reflect the current economic and financial climate. If so, it could fluctuate around this sort of level.
However, some may speculate that the fall has further to go – that indices are still too high to reflect the earning potential of companies – that the price–earnings ratio is still too high for most shares. If this is the majority view, share prices will indeed fall.
Others may feel that 14.4% is an overcorrection and that the economic climate is not as bleak as first thought and that the Omicron coronavirus variant, being relatively mild for most people, especially if ‘triple jabbed’, may do less economic damage than first feared. In this scenario, especially if the tensions over Ukraine are diffused, people are likely to buy shares while they are temporarily low.
But a lot of this is second-guessing what other people will do – known as a Keynesian beauty contest situation. If people believe others will buy, they will too and this will push share prices up. If they think others will sell, they will too and this will push share prices down. They will all desperately wish they had a crystal ball as they speculate how people will interpret what central banks, governments and other investors will do.
Articles
Questions
- What changes in real-world factors would drive investors to (a) buy (b) sell shares at the current time?
- How does quantitative easing affect share prices?
- What is meant by the price-earnings ratio of a share? Is it a good indicator as to the likely movement of that share’s price? Explain.
- What is meant by a Keynesian beauty contest? How is it relevant to the stock market?
- Distinguish between stabilising and destabilising speculation and illustrate each with a demand and supply diagram. Explain the concept of overshooting in this context.
- Which is more volatile, the FTSE 100 or the FTSE 250? Explain.
- Read the final article linked above. Were the article’s predictions about the Fed meeting on 26 January borne out? Comment.
Share prices are determined by demand and supply. The same applies to stock market indices, such as the FTSE 100 and FTSE 250 in the UK and the Dow Jones Industrial Average and the S&P 500 in the USA. After all, the indices are the weighted average prices of the shares included in the index. Generally, when economies are performing well, or are expected to do so, share prices will rise. They are likely to fall in a recession or if a recession is anticipated. A main reason for this is that the dividends paid on shares will reflect the profitability of firms, which tends to rise in times of a buoyant economy.
When it first became clear that Covid-19 would become a pandemic and as countries began locking down, so stock markets plummeted. People anticipated that many businesses would fail and that the likely recession would cause profits of many other surviving firms to decline rapidly. People sold shares.
The first chart shows how the FTSE 100 fell from 7466 in early February 2020 to 5190 in late March, a fall of 30.5%. The Dow Jones fell by 34% over the same period. In both cases the fall was driven not only by the decline in the respective economy over the period, but by speculation that further declines were to come (click here for a PowerPoint of the chart).
But then stock markets started rising again, especially the Dow Jones, despite the fact that the recessions in the UK, the USA and other countries were gathering pace. In the second quarter of 2020, the Dow Jones rose by 23% and yet the US economy declined by 33% – the biggest quarterly decline on record. How could this be explained by supply and demand?
Quantitative easing
In order to boost aggregate demand and reduce the size of the recession, central banks around the world engaged in large-scale quantitative easing. 
This involves central banks buying government bonds and possibly corporate bonds too with newly created money. The extra money is then used to purchase other assets, such as stocks and shares and property, or physical capital or goods and services. The second chart shows that quantitative easing by the Bank of England increased the Bank’s asset holding from April to July 2020 by 50%, from £469bn to £705bn (click here for a PowerPoint of the chart).
But given the general pessimism about the state of the global economy, employment and personal finances, there was little feed-through into consumption and investment. Instead, most of the extra money was used to buy assets. This gave a huge boost to stock markets. Stock market movements were thus out of line with movements in GDP.
Confidence
Stock market prices do not just reflect the current economic and financial situation, but also what people anticipate the situation to be in the future. 
As infection and death rates from Covid-19 waned around Europe and in many other countries, so consumer and business confidence rose. This is illustrated in the third chart, which shows industrial, consumer and construction confidence indicators in the EU. As you can see, after falling sharply as the pandemic took hold in early 2020 and countries were locked down, confidence then rose (click here for a PowerPoint of the chart).
But, as infection rates have risen somewhat in many countries and continue to soar in the USA, Brazil, India and some other countries, this confidence may well start to fall again and this could impact on stock markets.
Speculation
A final, but related, cause of recent stock market movements is speculation. If people see share prices falling and believe that they are likely to fall further, then they will sell shares and hold cash or safer assets instead. This will amplify the fall and encourage further speculation. If, however, they see share prices rising and believe that they will continue to do so, they are likely to want to buy shares, hoping to make a gain by buying them relatively cheaply. This will amplify the rise and, again, encourage further speculation.
If there is a second wave of the pandemic, then stock markets could well fall again, as they could if speculators think that share prices have overshot the levels that reflect the economic and financial situation. But then there may be even further quantitative easing.
There are many uncertainties, both with the pandemic and with governments’ policy responses. These make forecasting stock market movements very difficult. Large gains or large losses could await people speculating on what will happen to share prices.
Articles
Questions
- Illustrate the recent movements of stock markets using demand and supply diagrams. Explain your diagrams.
- What determines the price elasticity of demand for shares?
- Distinguish between stabilising and destabilising speculation. How are the concepts relevant to the recent history of stock market movements?
- Explain how quantitative easing works to increase (a) asset prices; (b) aggregate demand.
- What is the difference between quantitative easing as currently conducted by central banks and ‘helicopter money‘?
- Give some examples of companies whose share prices have risen strongly since March 2020. Explain why these particular shares have done so well.
Thirty years ago, on Monday 19 October 1987, stock markets around the world tumbled. The day has been dubbed ‘Black Monday’. Wall Street fell by 22% – its biggest ever one-day fall. The FTSE 100 fell by 10.8% and by a further 12.2% the next day.
The crash caught most people totally by surprise and has never been fully explained. The most likely cause was an excessive rise in the previous three years, when share prices more than doubled. This was combined with the lack of ‘circuit breakers’, which today would prevent excessive selling, and a ‘herd’ effect as people rushed to get out of shares before they fell any further, creating a massive wave of destabilising speculation.
Within a few weeks, share prices started rising again and within three years shares were once again trading at levels before Black Monday.
Looking back to the events of 30 years ago, the question many fund managers and others are asking is whether global stock markets are in for another dramatic downward correction. But there is no consensus of opinion about the answer.
Those predicting a downward correction – possibly dramatic – point to the fact that stock markets, apart from a dip in mid-2016, have experienced several years of growth, with yields now similar to those in 1987. Price/earnings ratios, at around 18, are high relative to historical averages.
What is more, the huge increases in money supply from quantitative easing, which helped to inflate share prices, are coming to an end. The USA ceased its programme three years ago and the ECB is considering winding down its programme.
Also, once a downward correction starts, destabilising speculation is likely to kick in, with people selling shares before they go any lower. This could be significantly aggravated by the rise of electronic markets with computerised high-frequency trading.
However, people predicting that there will be little or no downward correction, and even a continuing bull market, point to differences between now and 1987. First, the alternatives to shares look much less attractive than then. Bond yields and interest rates in banks (at close to zero), unlike in 1987, are much lower than the dividend yields on shares (at around 4%). Second, there are circuit breakers in stock markets that suspend dealing in cases of large falls.
But even if there is a downward correction, it will probably be relatively short-lived, with the upward trend in share prices continuing over the long term. If you look at the chart above, you can see this trend, but you can also see periods of falling share prices in the late 1990s/early 2000s and in the financial crisis of 2008–9. Looking back to 1987, it seems like a mere blip from the perspective of 30 years – but it certainly didn’t at the time.
Articles
Three decades since Black Monday – are markets on the verge of another tumble? The Telegraph, Lucy Burton (19/10/17)
Black Monday: 30 years on from the 1987 crash Citywire, Michelle McGagh (19/10/17)
30 Years Ago: Lessons From the 1987 Market Crash U.S.News, Debbie Carlson (12/10/17)
Black Monday: Can a 1987-style stock market crash happen again? USA Today, Adam Shell (19/10/17)
Black Monday anniversary: How the 2017 stock market compares with 1987 MarketWatch, William Watts (19/10/17)
30 years after Black Monday, could stock market crash again? MarketWatch, William Watts (19/10/17)
The Crash of ’87, From the Wall Street Players Who Lived It Bloomberg, Richard Dewey (19/10/17)
Questions
- Explain what are meant by ‘bull markets’ and ‘bear markets’.
- Share prices are determined by demand and supply. Identify the various demand- and supply-side factors that have led to the current long bull-market run.
- What caused the Black Monday crash in 1987?
- For what reasons may global stock markets soon (a) experience, (b) not experience a downward correction?
- Distinguish between stabilising speculation and destabilising speculation on stock markets.
- What determines when a downward correction on stock markets bottoms out?
- Explain how stock market circuit breakers work. Can they prevent a fundamental correction?
- Does the rise in computerised trading make a stock market crash more or less likely?
One of the biggest consequences of the recession has been a rise in unemployment. As the economy fell deeper into recession, unemployment began to soar and some believe that it could reach 3.5 million and remain high for the next decade.
But while many employees have lost their jobs or had they pay frozen, some of the biggest earners have received substantial pay rises! The bosses of the FTSE 100 companies have seen their average pay increase by 10% and have shared pay rises of more than £1 billion in the past year.
So as the economy plunged into recession and companies lost much of their value, we still saw an increase in the pay gap in the UK. The following articles look at the pay situation of some of the top bosses.
10% pay rise for the top bosses This is Money, Ryan Kisiel (14/9/09)
Guardian Executive Pay Survey 2009: Should pay be capped? Guardian (14/9/09)
What they make: The highest paid Chief Executives in Digital Media Guardian (20/3/09)
Executive pay jumps despite recession: Report Associated Press (14/9/09)
Unemployment could reach 3.5m and remain high for a decade, CIPD warns Telegraph, Martin Beckford (14/9/09
Questions
- How are wages determined in the labour market?
- Why do different people receive different wages? What should happen if two people receive different wages for doing the same job?
- What are the different (a) types (b) causes of inequality?
- Would a maximum price work if it was applied to wages?
- Discuss the advantages and disadvantages of different wages. If everyone was paid the same, would everyone be better off?
