If we try to analyze past bull runs and bear downturns, there are several observations that can be made. Though these observations tell a tale, the usual disclosure that ‘there are no absolute truths about stock markets’ continues to apply here.  Today I wanted to reflect on some observations I have made about stock markets over the years and how I am viewing the global stock market carnage of the last few days.

One of the things I have always seen about stock markets is that they always tend to overdo it. While a stock price over time tends to hover around the intrinsic value of the stock, more often than not, it swings like a pendulum around it due to a mix of macroeconomic and sentimental factors. So, if there is a bad news, panic sets in and the markets tend to free fall much below intrinsic value before sanity sets in and they come back. The same holds on the positive side too. Another important aspect is that the global economic climate influences the market mood and often hampers proper market decision making. So, if the going is good and markets are doing well globally, any bad news often just gets ignored. The same bad news creates havoc if markets are in a downswing. It is as if when the going is bad, markets almost hunt for bad news to justify where they are and react even more negatively when the news sets in.

Well, I thought that I should pen down some thoughts on this critical issue which is threatening to pull the American economy back into recession.  To begin with, let’s understand some basic concepts that govern the issue at hand. First of all, its important to understand that printing of money in any country is controlled by that country’s Central Bank. Eg. It’s the RBI in India and the Fed in the US. The Central bank has a critical role to play. If they print a lot of money or leave interest rates very low, that would drive up liquidity leading to high inflation. If they do the reverse, inflation might be low but there won’t be enough capital to do business in the country, hence the GDP will go down leading to poorer lifestyles of the masses. Hence, these Central banks have an important role to play as they decide liquidity flow in the country. They act independently and are supposedly run by very competent economists.

The government of a country is like a large organization that spends money for the upliftment of   its people. This money comes either through taxes or by raising debt by issuing bonds. Government spending is very important as it leads to large scale creation of jobs for the masses and also helps people attain better lifestyles. Sometimes, a situation arises when the government runs out of money and in order to meet its spending obligations needs to either raise taxes (which is a politically suicidal move) or raise money through debt. As long as the debt remains within certain limits, borrowing can be a good idea. However, if the debt reaches dangerously high limits, raising more funds through debt can only create a fiscal deficit time bomb waiting to explode.