Q&A: What’s happening to stock markets?

Billions of pounds have been wiped off the values of shares after stock markets suffered their biggest falls since the collapse of US investment bank Lehman Brothers in September 2008, last week.

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The FTSE 100 Index of Britain’s largest companies fell 5.6% to 5,067 and experts are warning of continuing turmoil in the coming days.

This latest bout of extreme volatility stems from fears that the world economies are on the brink of another recession, and the European debt crisis is at the heart of the problems.

While many may think this has little to do with us here in the UK, those with stock market investments know it definitely does. If you have a pension, you’re affected and even if you don’t there are reasons why the current turmoil could have an impact on you.

Here, we take a look at what is causing the stock market turbulence and what you should do…

What’s happened ?

Share prices around the world plunged after the United States’ central bank, the Federal Reserve warned last Wednesday that despite measures it has implemented to stimulate growth, the US economy remains perilously weak and a return to recession cannot be ruled out. Stock markets hate uncertainty and this news prompted global markets to go into freefall.

Europe is the epicentre

While it was news from across the US that precipitated the latest round of share price falls, the debt crisis in Europe is the core of the problem.

There are mounting fears that Greece is on the brink of defaulting on its debt repayments and markets are concerned about the effect that might have within the eurozone. Fears of economic weakness have already spread across Europe to Spain, Italy and France and last Monday credit ratings agency S&P lowered its rating for Italy from A+ to A. The International Monetary Fund has also cut its growth estimated for Europe the US and Japan. 

Chancellor George Osborne has said that the eurozone has just six weeks to fix the crisis, warning that failure to do so could risk a world economic meltdown. The G20, which is made up of the finance ministers and central bank governors from the world’s largest economies, spent the weekend working on €2trillion rescue plan.

Why does Europe need bailing out?

The root cause of this global financial crisis stems from the fact that the world is over-indebted. From individuals up to governments we have borrowed too much and in many instances, are now struggling to pay it back.

The most immediate concern is the state of the Greek economy. The Greek government has already received one bailout from the EU but now needs another in order to avoid defaulting on its loan repayments. It is reported that as part of the rescue plan, 50% of Greece’s debt will be written off.

The problem is that the Greek debt crisis isn’t just a national problem because banks from other countries, particularly France, have lent Greece money. Therefore if the government misses loan repayments the financial stability of a number of European investment banks could be put at risk. One of the most exposed is French bank, Societe Generale. Consequently, one of the elements of the G20 rescue package is a capital injection to shore up the reserves of the banks so that they won’t be as vulnerable if Greece does default.

There are also fears that the problems Greece is facing could spread to other weak European economies such as Spain, Portugal and Italy hence the need for emergency action. If that were to happen the European financial system really would be in jeopardy as their debts are much greater than those of Greece.

What does all this mean for me and what should I do?

Think carefully if you have stock market investments

Selling your investments now means you will only crystallise your losses. While it may be extremely worrying seeing the value of your funds fall, most experts advise trying to sit tight and take a long term view. Investors frequently make heavy losses by panic-selling, so if you are able to weather the current storms you should probably try to do so.

People who are about to retire are among those hardest hit by stock market volatility as the value of their pension pots is likely to have reduced significantly in recent weeks. This means that less money is available to purchase an annuity with a potential reduction in retirement income for the rest of their lives as a result. Anyone contemplating retirement should seek professional independent financial advice before committing themselves to any particular course of action.

Spread your savings

While no one is warning that a bank is on the brink of collapse, given the current uncertainty it’s worth ensuring that all your savings are protected just in case the worst happens. Under the terms of the Financial Services Compensation Scheme the first £85,000 held with a single institution is protected (£170,000 if the account is in joint names). Therefore if you have more than £85,000 in cash savings you can protect it all by spreading it around between different institutions. For more on this, read our article ‘Who owns who?’.

Pay down debt

Some economists are already saying Credit Crunch II has begun and even if the eurozone does receive a bailout, we may see banks and building societies restrict the availability of credit and push up the cost of loans, credit cards and mortgages.

If you have any outstanding debt it is worth trying to pay it down now as quickly as possible because not only could we see the cost of borrowing rise, but credit may become harder to come by again. For advice and information about the best credit card and loan rates, read Jessica Bown’s article ‘Tips if you’re trying to clear debt’.

It’s also important to note that many economists believe we could slip back into recession next year with some warning of decades of low growth ahead. This will have an impact on job creation and we may see unemployment rise so it’s worth getting your own personal finances in as strong a position as possible, just in case your circumstances change.

Remortgage now

If you’re looking for a mortgage because your current deal has ended or is about to end, it seems unlikely that mortgage rates are likely to get much cheaper. With fixed and tracker rates already at historic lows, mortgage experts are recommending that borrowers snap these up while they’re still available.

There are already signs that mortgage rates may be about to climb with inter-bank lending rates having increased in recent weeks and if banks do become more cautious about lending again borrowing costs will go up even if the Bank of England base rate remains low.

Visit our mortgage channel to find the best mortgage deals.

Please note: Any rates or deals mentioned in this article were available at the time of writing.

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