LONDON — There is a “significant possibility” of a major stock market correction in the near future which could drag down global economic growth, according to recent analysis from staff at research house Oxford Economics.
Writing on Tuesday, Oxford’s global head of macro research Gabriel Sterne argued that a 10% fall in global markets, caused by a reduction in “irrational exuberance,” could have the potential to wipe as much as 0.3% off growth in major economies.
“Given the extent of overvaluation currently, a shock to market confidence – an end to irrational exuberance – could lead to sharp price falls,” Sterne wrote in the note.
“But there are also more fundamental risks, including disappointing global growth, a reversal in lowflation, a slowdown in China and further setbacks related to Trump’s policy initiatives.”
It should also be noted that Oxford’s note was circulated prior to the recent escalation of tensions between the USA and North Korea, which has already had a marked negative impact on global sentiment.
Stocks around the world have rallied strongly during 2017, with all three major benchmarks in the USA frequently breaking to new record highs this year. The pattern has been similar in the UK, where in January the FTSE 100 went on a streak of more than 10 days of consecutive new highs. Those days could be close to an end, the note suggested.
“A 10% decline in equities triggered by a loss of market confidence would reduce the level of both consumption and GDP on average by a little over 0.3% across advanced economies, according to our model simulations, with the peak impact occurring after four to six quarters,” Sterne continues.
“The impact is broadly in line with the intuition that the magnitude of the impact on consumption will be higher: (i) the more wealth consumers start with; and (ii) the sharper is consumers’ reaction to any given change in wealth.”
The impact, Oxford’s note argued, would differ between economies, but it is likely that countries with higher overall market capitalisations would be the worst affected by the correction.
That puts the USA and the UK in the firing line for major losses, as the chart below illustrates:
“We would expect that economies with very high stock market capitalisations (including the US and UK) would be more severely affected,” Sterne writes.