Is the Stock Market Crash a Healthy Correction Or the End of the Boom?

Stock market crash and rising volatility: What is happening right now in the equity markets? Which way will prices go? Learn what triggered the stock market storm and why the correction is no reason to panic.

Despite good economic conditions, stock markets are currently correcting globally. What are the reasons and what happens next? "There is much to be said for a healthy market correction," said Burkhard Varnholt, CIO for Switzerland and Deputy Global CIO at Credit Suisse, of the recent stock market turmoil. The current losses are not a turning point, but were triggered by panic sales of trailing investors.

Nevertheless, the stock market crash will have consequences: "Stock market sentiment will likely change soon. Many investors have been waiting for the correction," said Burkhard Varnholt. Now it has arrived and offers a good buying opportunity. Volatility will remain accordingly high in the coming weeks. A long-term comparison also shows that the recent correction is no reason to panic. In the long term, shares and bonds will yield returns.


Excess returns on shares and bonds since 2000 are compensating investors for the risk of stock market storms

Source: Bridgewater Associates

Fear of Inflation Led to Stock Market Crash

But what was actually the reason for the stock market crash? Burkhard Varnholt sees the cause as being the rise in US 10-year yields from 1.6 percent to over 2.8 percent. "Rising interest rates point to a slight increase in inflation, especially in the US." Many investors fear inflation. However, the fact that the stock market storm discharged so violently is due to the parallel sale of many automatic trading programs. These acted as a kind of accelerant.

Although inflation is clearly negative for bonds, it is actually positive for shares — at least to a moderate extent. It would lead to a reallocation of bonds into shares. Institutional investors in particular would be in a tight spot. Moderate inflation should therefore provide fresh momentum for share prices.

Inflation Is Likely to Remain Moderate

But how real is the danger of inflation? Structurally, there's a lot to be said against inflation. Digitalization, globalization, productivity gains, labor market reserves, and the lack of inflation-indexed wages are just some of the factors.

Cyclically, however, isolated inflationary pressures cannot be overlooked, especially in the USA. This will likely remain temporary and correct itself independently. "A sustainable excess of the monetary policy inflation target range of about two percent seems unlikely," emphasizes Burkhard Varnholt.

You can't predict what a share will do... in the short term. But you can predict that companies will perform well over time.

Warren Buffett

Parallels to the Stock Market Crash of 1987

Historical comparisons are usually constructed. Nonetheless, the current situation parallels the stock market crash of 1987. Then — much like now — the global economy was strong and the stock markets had already experienced a long-lasting upturn. Worries about inflation, a weaker dollar and the US trade deficit increased the yield on ten-year US bonds.

Then, on Black Monday, October 19, 1987, the American Stock Exchange plummeted out of the blue. The global stock markets snowballed. Automatic trading programs — much like this week — were responsible for fanning the flames.

Share Prices Increasing in the Long Term Despite Stock Market Crash

"Looking back, we know that this quick sell-off created a rare buying opportunity for investors with nerves of steel," said Burkhard Varnholt. "Even those who did not bother selling at the time saw that the Dow Jones Index was higher at the end of 1987 than at the beginning of the year."

This shows that a robust investment process creates more lasting value than running after short-term trends. Or as Warren Buffet puts it: "Price is what you pay, value is what you get."

A Different Situation than the 2008 Stock Market Crash

Especially since we are currently far removed from an environment that prevailed in 2008. The financial crisis was triggered by weak economic activity, the US mortgage crisis, and a global banking crisis. However, today the global economy is robust. Global consumption appears to still be stable. Share valuations are moderate in comparison to bonds, and in absolute terms are even cheaper than a year ago in many places.

Therefore, the higher volatility will, above all, create new investment opportunities. Share prices will recover, investors will "scout for bargains" and then remember the Asian proverb: "The night is darkest just before the dawn."