Is stock market turmoil a signal to panic?

The stock markets have got off to a clunky start in 2016.

In the first week of the year the Chinese stock market was halted by an automatic mechanism twice - on the second occasion just 29 minutes after the opening bell after stocks plunged by seven per cent. The FTSE-100 has fallen more than six per cent so far and today hit a three-year low.

“Shock waves reverberated around global markets,” says Hazel Sheffield in The Independent.

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Now a survey by YouGov has found that more than half of us believe there will be another financial crisis in 2016. It’s a view that seems to be shared by the Chancellor, George Osborne. He has started the year by saying the UK faces a “dangerous cocktail” of economic risks and that 2016 would be the “year of mission critical”.

Is it time to stick your cash under the mattress and prepare for the worst?

The answer to that depends very much on who you believe. The Guardian has warned of “the great 2016 financial crisis” while several columnists in the Daily Telegraph, as well as the Financial Times' Martin Wolf, have said that a recession isn’t on the cards.

The key is to understand that a bad time for the stock markets doesn’t automatically mean the national economy, or for that matter the global economy, is going to falter.

Markets do not by any means truely reflect conditions the real economy - just as they didn't during a multiyear bull run that probably ended last year and left most indices at very high levels. So this year could be bad for stock market investors, but that isn’t necessarily going to lead to an economic meltdown.

RBS has shocked the market this week by warning investors to “sell everything” as it believes markets could fall 20 per cent this year. The bank stated: “In a crowded hall, exit doors are small. Risks are high”.

“Yes, the slump in the stock market is bad news for investors, savers and companies seeking to raise funds. Yes, China’s handling of its slowdown and market has been problematic,” says Allister Heath in The Telegraph. “But none of this means that a recession is on the cards in Britain.

What is happening in the markets?

There is certainly a lot of turmoil in the stock markets at the moment. Concerns over the Chinese economy is making markets around the world rocky - and the oil price is falling fast.

But, these aren’t shocking game changers. The Chinese market is in a long-term transition to a more demand-led economy and was giving the world concern for most of 2015 and earlier. The oil price has been on a downward trajectory for some time, caused primarily by an arm wrestle between the big global producers that has left the world oversupplied.

“Nothing truly substantial has changed over the past few days in terms of economic and financial fundamentals,” says Heath. “The emerging market rout is still ongoing, dragged down by China, Brazil and other economies. The price of oil remains on a downwards trend, for reasons of supply as well as demand. American interest rates are still on a slow, upwards trajectory. The eurozone is still past the worst.”

How is the UK coping?

“If you look hard enough you can always find somebody telling you the markets are about to crash, but they are normally wrong. Historically equities have been the best asset class over the long term – listening to the doom-mongers has been a mistake,” says Ben Brettell, senior economist at Hargreaves Lansdown, in The Guardian.

“Disappointing industrial production figures suggest the [UK] economy slowed towards the end of 2015, and is still heavily reliant on consumer spending. However, growth is steady (if unspectacular), the labour market continues to show encouraging signs and interest rates look unlikely to rise any time soon.

"Add in the fact that the UK stock market looks fairly valued relative to its history using a price/earnings measure, and the investment climate doesn’t look too bad to me.”

So the economy is safe?

Let's not go too far. It's true that you shouldn't see markets falling and infer that the economy will collapse, but if Chinese demand slumps faster than expected or there are any major shocks then things could certainly turn south fast.