Is major stock-market correction impending?

Is major stock-market correction impending?

The first week of the new year saw an across-the-board decline in stock prices around the world. The Korean financial markets were no exceptions, losing market value, in the case of the Korea Stock Exchange, of as much as 10.4 percent in just three trading days.


The latest blood-letting began with a plunge in the US exchanges including the New York Stock Exchange and the Nasdaq market. The Nasdaq, listing many volatile tech stocks, lost 9.8 percent of its market value within the same days, closely approaching the psychological threshold of a major market correction of 10 percent.


Although there are varied explanations as to the causes, many attribute the losses to renomination of Federal Reserve chairman Alan Greenspan for a fourth term, seeing this as a signal that the Fed will almost certainly raise interest rates in the coming February meeting of its Open Market Committee.


Others point out that, with the economy unscathed by the Y2K problem, the Fed is calling in the extra liquidity it had injected into money markets near the end of last year. Just as initial injections led to the year-end run-up, the logic goes, so the withdrawal would take steam out of the sizzling market.


Whatever the causes, a question remains: Is this sell-off going to last for the time being, at least until the Fed's rate hike in early February? At first blush, it seems unlikely, especially considering subsequent rebounds like that of Friday, January 7. Tech stocks, hardest hit by the decline, are on their way to gaining their previous highs. Korean stocks are following suit, reclaiming 4.01 percent on Monday, January 10, alone. However, many market watchers warn that the rate jitters have not ended yet.


Some forecast that the Fed will hike interest rates three or four more times within the year, jacking up the federal funds rate to perhaps 7 percent or higher from a current 5.01 percent.


As a matter of fact, the US economy has for the last 9 years of expansion been sustained by the strong performance of its stock markets. When stock holdings of individual investors appreciate in value, they will feel like spending more money even if they have not cashed out those paper profits. Some of those investors may shell out tens of thousand dollars on big-ticket items such as luxury cars and home entertainment systems, raising consumer spending as a whole and supporting economic growth (two-thirds of which consists of consumption).


This wealth effect will disappear once the stock market, after a bout of rate hikes, undergoes a correction which no doubt will slow the whole economy with it.


Of course, there are many so-called New Economy companies that defy the conventional wisdom that high borrowing costs undermine profitability and equity values. Many of these tech companies don't even borrow capital. They instead rely on venture capitalists and initial public offerings that make them overnight millionaires. For these firms, high interest rates do not mean much, quite unlike such interest rate-sensitive businesses as autos and farm equipment.


Nevertheless, interest rates still matter. It is not only because a majority of the economy belongs to sectors heavily affected by interest costs, but also because consumers will think twice before opening their wallets whenever their loan and credit card rates go up by a notch.


It is a well known fact that Korea's stock markets, the Korea Stock Exchange and the KOSDAQ, are highly sympathetic with movements of their US counterparts. By some estimates, the two countries' markets have a correlation coefficient of 0.80 (while that of the KSE and the KOSDAQ is less than 0.50), showing a close synchronization between the markets of the two nations. This means that interest rates worries in the US are not just someone else's problem, but also our own.



So just for now, the appropriate advice to Korean investors would be: Hold until things settle, unless you want risky momentum trading regardless of where the market is headed.