Ripple Effect--or Tidal Wave?
Thursday’s stock market declines in the United States, coming after sharp falls in the Hong Kong stock market, may be worrisome to U.S. investors fearing that events halfway around the world are exerting a major influence on their own portfolios.
Here are some basic questions that American investors might have about how foreign markets affect U.S. stocks and bonds and whether the latest declines presage further trouble.
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Q: We’re thousands of miles from Hong Kong. Why should something happening there cause problems for U.S. stock markets?
A: Because the global flow of investment money, as well as the scale of international trade, ties all major markets and world economies together to a degree. U.S. investors own foreign stocks and bonds, and U.S. companies sell goods abroad. Faltering Asian markets mean that American investments in that region are losing value and that the market for American goods will shrink, at least in the short term.
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Q: Have the problems in Asia taken everybody by surprise?
A: Only to the extent they are affecting Hong Kong. Other Asian markets, including Thailand, Indonesia, Singapore and Japan, have been weak for months. Almost all have sharply devalued their currencies to reflect their weakening economies. Hong Kong, whose dollar is pegged at a fixed rate to the U.S. dollar, was the lone holdout. The turmoil in the Hong Kong market reflects investor fears that it may have to capitulate by devaluing its dollar, too.
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Q: But for years Wall Street has been urging us small investors to place more of our money in overseas markets in order to diversify. Have the latest events in Asia blindsided people who followed that advice?
A: Not entirely, because not all investors in foreign markets have remained heavily invested in Asia. Managers of “overseas” mutual funds, for example, have the authority to invest anywhere in the world (including keeping money in the U.S.). Many of them bailed out of Asian markets as the entire region slumped. On the other hand, managers of Asia funds--those constrained to invest in the region--may have found it harder to step out of the way of the rippling problems.
In any event, all investors should remain aware that investing overseas, whether in “emerging” markets like Thailand or established ones like Great Britain, Japan or Germany, tends to involve higher risks than keeping money at home. American investors face risks from foreign currency and interest-rate changes. It is often harder to analyze and understand foreign investments than domestic ones, and many of those markets are less liquid than those in big industrial countries--and thus harder to sell out of when the time comes.
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Q: What about the impact of this turmoil on my American investments? Most of my retirement money, including my company 401(k) account, is in stocks. Should I reconsider my investment mix?
A: You should never make snap decisions about your investments based on a single day’s market performance or that of a short stretch. That’s especially true of retirement funds, which deliver their greatest benefit by remaining invested over long periods of time. In fact, moving your investments in and out of markets based on short-term considerations is one of the surest ways to stunt their growth.
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Q: Is there anywhere my money is safe?
A: If safety is your primary concern, you might look at the market in U.S. government debt. The U.S. Treasury markets surged Thursday, with the 30-year U.S. bond gaining nearly 1 1/2 points to yield 6.30%. That means holders of U.S. bonds pocketed a nice gain for the day, in part because investment or regional turmoil often provokes investors into a rush to safety, and U.S. treasuries are about the safest investments anywhere. On the other hand, for a long-term investor, a yield of 6.30% a year is not very inviting and over time would probably represent a grimly under-performing portfolio.
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Q: But isn’t Thursday’s U.S. stock market drop an alarming signal?
A: Not necessarily. Declines in the Dow Jones industrial average of more than 100 points have been almost commonplace this year; this is the 10th, and only the fifth-most-severe in point terms. Because the Dow’s overall level is high, in percentage terms Thursday’s 186.88-point decline only ranks 10th in severity.
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Q: What about the rest of my portfolio? Some stocks are obviously weaker than others. Should I try culling the herd?
A: Investment pros are indeed examining how Asian economic turmoil might affect individual American companies, many of which have considerable business interests overseas in general and in Asia in particular.
“Usually, something that would happen in Hong Kong wouldn’t affect us,” said M. David Testa, chief investment officer at the mutual fund firm T. Rowe Price. “But the repercussions might be sufficiently severe that it would affect the earnings of companies here. People are trying to figure out which ones.”
Among those in strategists’ sights are Coca-Cola, Merck and IBM, three Dow industrial stocks that were down sharply Thursday. Also subject to redoubled scrutiny are a host of technology stocks, which similarly depend on healthy overseas markets; that’s why the Nasdaq composite average, which is laden with tech stocks, almost matched the Dow with a 36.83-point, or 2.16%, decline.
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Q: I thought my stock investments were doing so well. Does this mean I’m now in the red?
A: Only if you’ve been invested for less than a month. Thursday’s U.S. declines knocked the Dow and Nasdaq averages back to where they were in roughly mid-September. Coming after vigorous bull runs for both averages, that’s not an unusual backpedaling. In fact, both averages continue to show historically lavish gains so far this year: The Dow is up 21.8% year-to-date, and the Nasdaq composite is up 30.49%.
It’s precisely those gains that contributed to the U.S. markets’ sharp reactions to Hong Kong’s malady Thursday. When markets steam ahead so far so fast, they’re vulnerable to any factors that look like excuses for people to turn their paper profits into cash. It may be that such a phenomenon accounted for some of Thursday’s action.
