This article expects to change your view about the stock market and its reactions to the different external factors. Pandemics, natural disasters, economic blockades, wars, and political scenarios are a few of the external factors that I would like to jump into. We will be analyzing the reactions of the stock markets, both national and international, to these factors in detail. These factors obviously affect the earnings of the companies in a major way. We will be talking about corporate earnings taking reference to times when the countries around the world are experiencing these factors as well.
Pandemic, Lockdown, & Economic Blockade:
Let's begin with the pandemics because we are experiencing one of them in real-time. The investors in the Nepalese stock market were expecting NEPSE to plunge below the index of 800 after the first phase of lockdown enforced by COVID-19. It did not happen. There have been different phases of lockdowns and yet the market keeps climbing up. We are about to analyze the current market condition.
When the first phase of COVID-19 enforced a lockdown, NEPSE had already begun to continue its bullish momentum after the Bearish Market of three years long, from 2016 to 2019. The market always moves in a cycle. Even though the news of the pandemic might create further short-term fluctuations, in the long run, the market will move towards its momentum. However, it can either be Bullish or Bearish, depending on where we are on the market cycle.
Let me present to you the historical evidence of the reaction of the stock market towards one of the previous pandemics. We will be talking about the Spanish Flu. The Spanish Flu spread across the globe from 1918 to 1920. In October of 1918, the American stock market began to fall. The fall continued till February of 1919. In the span of four months, the stock market had dropped by 10.95%. Then, the market continued to move in its bullish direction. The Spanish Flu did not have long term effects on the American Stock Market.
In Nepal, the NEPSE index fell by almost 29% because of COVID-19 and now it is back to its bullish momentum. So, it is necessary for investors to understand where we are in the stock market cycle. Pandemics might create short term stock market fluctuations but in the long run, it doesn't matter. If the market cycle is Bullish, it will go up. However, if the market cycle is Bearish, it will continue to crash down no matter how good or how bad the economy is.
In 2015, when India imposed an economic blockade towards Nepal, the stock market had a negative reaction in the short term and that was reflected in the market fluctuations. But it pushed the corporate earnings higher as the corporations could raise the prices of their products. We can see that the economic blockade didn't really have much effect on the performance of the stock market. The market began to fall after the completion of its Bullish run in 2016 and has recently completed its Bearish run in 2019.
Since the stock market moves in cycles, natural disasters do not have direct effects on the performance of the stock market. If natural disasters were to affect the performance of the stock market, then Japan would have the worst stock market in the world because the frequency of earthquakes in Japan is very high. Such is not the case and these disasters create short term market fluctuations. But in the long run, the market continues to follow its cycle.
In the case of Nepal, people believe that the companies couldn't sustain their earnings after the earthquake of 2015. Therefore, the market crashed in 2016. But this is untrue. Nepal has a historical cyclic pattern which includes 4 years of Bullish journey and 3 years of Bearish journey. We had experienced a Bullish run from 2012 to 2016. After the market completed this historical tenure of the Bullish run in 2016, the market crashed till 2019.
The stock market had dropped significantly as a reaction to the earthquake in 2015 for the short run. However, the market continued its Bullish run after things went back to normal. The earthquake did not cause the market to drop in 2016. Instead, the historical pattern and the liquidity crisis of 2016 caused the market to crash.
Wars and Political Scenarios:
I will obviously be clinging to my main point, the market follows its cycle, and external factors are the distractions from the dips where we can purchase stocks in cheap, here as well. Wars and political scenarios only affect the market in the short term. If the market is in its Bullish run, it will continue to go up, and if the market is in its Bearish run, it will continue to go down.
Nepal was going through a civil war from 1996 to 2006. However, the Nepalese stock market had reached its high in 2001 despite the ongoing Civil war. This theory can be backed up by two World Wars as well. When the First World War broke out in 1914, the American Stock Market had experienced a short-term fluctuation but it continued to move towards its Bullish rise.
When the Second World War broke out in 1939, the stock market was falling. However, the market had been falling from its previous high in 1937 before the Second World War even commenced and the market was only going down because it was in its phase of the Bearish cycle. The wars and political scenarios affect the stock market only in the short term.
Corporate Earnings During Pandemics, Natural Disasters, Economic Blockade, Wars, and Political Scenarios:
You might wonder, aren't these factors affecting the corporate earnings? If the corporations are not making any money, why would the stock market rise? You might add these pieces and come to the conclusion that the stock market is fake and it is rigged. There is more to these situations than the mere decrease in corporate earnings.
The countries obviously go through tough times when they go through these factors. Now, we should look closely at what the countries do when they are in bad economic conditions. They use another factor called quantitative easing, which is a fancy way to say the government prints a lot of money, which is expected to increase inflation.
Now, as inflation increases, corporations increase the prices of their products, which results in an increase in corporate profits. As these numbers roll out in the balance sheets of the corporations, the stock markets around the world soar upwards, if they are in their Bullish phase.
The stock markets always reflect the earnings of publicly traded companies. In a few cases, the stock market around the world predicts the future as well. You might ask, what about the companies with minimal or no earnings? Sometimes the stocks of the companies with no cash flow or minimal earnings are traded in a high range because of its future potential, which is usually reflected by the high PE ratio. For instance, Tesla and Shopify stocks are trading at a very high PE ratio as their future prospects look very profitable.
Therefore, we should understand that the stock market is not the economy. The stock market reflects the economy of a country in the long run. In real-time, the stock market reflects the current earnings of the companies as well as predicts the future earnings prospects of a few companies. The market will react to the factors mentioned above in the form of volatility. But in the long run, the stock market reflects the economy while remaining independent of the economy of the country.
If the country fails to adjust the level of inflation by creating less credit or by creating too much credit, then the economic disbalance resulting in slow economic growth or hyperinflation will invalidate the stock market. Believe it or not, Venezuela has a stock market as well and it is not good. A new system must be enforced when the whole economic system of the country fails. But when the country is on its way to economic prosperity, the stock market does not react to the external factors.
The market in a healthy economy will continue to rise and fall. But these occur in a set of patterns. In the Nepalese stock market, the pattern follows four years of Bullish run and three years of Bearish run. Currently, we are in the Bullish run and our government has set an unrealistic expectation of 7% economic growth. Let's enjoy this Bullish run backed by the hiked inflation.
Invest for the long term because the short-term fluctuations do not matter in the long run. Instead, take advantage of the volatility of the market by buying the dips. Always remember to be greedy when others are fearful and to be fearful when others are greedy. Happy Investing.
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Disclaimer: Investing can be risky and it can turn out to be hazardous as we grab a wrong notion of investing. So, do not take this article as financial guidance. Always consult a licensed CFO or portfolio manager for your particular investment plans and financial goals. Neither ShareSansar nor the author is responsible for the losses incurred in the stock market.