Why Share Prices Rise And Fall In A Crisis

The impact of coronavirus on the world economy has seen a dramatic fall in the demand for fuel, goods and services as businesses output less, incomes drop, and many workers lose their jobs.

The International Monetary Fund |(IMF) forecasts a 3% fall in global GDP in 2020 – which means the total value of goods and services of all countries is expected to drop.

That means different things to different countries.

Somewhere with a 6% or 7% GDP rate, like China, will still see economic growth, but nations like the UK, with a GDP output nearer 2% are likely to fall into recession.

Three triggers for equities to drop in value

The value of stocks and shares falls when the economy contracts for three main reasons:

  • Businesses make less profit, so shares in them are worth less
  • Investors are uncertain about the future, so are less willing to stake their money against a risky outcome
  • Investors want to protect their wealth, so move their money to ‘haven’ investments, like gold, bonds or cash

Essentially, buying shares in a company is taking a gamble on future earnings and profits rising, pushing up the value of the investment.

In a recession, the gamble is more uncertain and if investors believe recovery will take a long time, the share price is less likely to recover in the short term.

Unforeseen crisis is inevitable

Coronavirus has cast a shadow of uncertainty over the global economy like never before.

No one really knows if the virus is with us for good, how countries will exit the lockdown and what the markets for goods and services will be like when the infection subsides.

The key is how long scientists take to develop a vaccine.

On the plus side, falling share values are an opportunity for investors with money to drip feed back into the markets.

They can buy more shares cheaper than a couple of months ago and hopefully make more profits as their value rises in the future.

Although coronavirus is the worst pandemic in living memory, the threat of a crisis brewing is always present, and the takeaway is investors should plan for the unexpected because life inevitably throws up unforeseen events.

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