What The Heck Happened To The Stock Market?

Most of you probably did not notice the drop in your retirement accounts at the end of last week. CNN was still covering the story of the American guys on the French train, and frankly, there in nothing more pointless than staring at your 401k balance every day. This morning, however, CNN and the rest of the media are off to a roaring start on the topic of stock markets. While we were sleeping, China's market gave in to the fears of a crash... and crashed. Which led the European markets to fall into a bit of a frenzy during the wee hours of our morning. Which caused our own market traders and press to fall into a tizzy over their morning coffee. And there you are; a news story to rival failed terrorist attacks. So, is this the crash we've been dreading?

Probably not. Don't get me wrong, this is going to hurt in China, where we have suspected for months that the amount of money (much of it borrowed) in Chinese stocks is excessive. And the amount that middle-class Chinese investors lose here could well cause problems for some companies that depend on those Chinese consumers. But very few people outside China are invested in this market. In fact, it was only in October of last fall that China began to give out licenses allowing foreign investors to buy directly into their markets. And that move itself was a sign of China's new direction.

The Chinese economy has grown by leaps and bounds for years now. Economists like to measure the size of a nation's economy by calculating Gross Domestic Product (GDP). Roughly speaking for our purposes, GDP takes one year of information and adds together how much a nation's consumers spent, how much the government spent, how much businesses invested and how much was exported minus how much was imported in that year. To figure out whether a country's economy is going forward or backward, we compare that number to how much the economy produced the year before

In its best years, China's GDP has grown by as much as 14.2% from one year to the next. And China has had no difficulty getting its GDP to grow about 7% to 8% a year since 2012. That number seems to be steadily dropping, though, which means that while China's economy is still getting bigger and richer every year, it may only be by 6% instead of 7%.

You might be thinking that this doesn't sound like such a bad problem to have. And you'd be right. Consider this—for 2014, the annual growth rate of the U.S. was 2.3%, the U.K. was at 2.6%, and Germany was at 1.6%. Among the "highest performing" countries in terms of growth rate were South Sudan (36.2%), Sierra Leone (13.8%) and Papua New Guinea (8.4%). The fact is that 2% of a lot is still bigger than 36% of next to nothing.

So why is China in panic mode? What all the figures are telling us is that China is no longer (and hasn't been for a while now) an "emerging market" or a "developing country." It is a significant player in the global economy with a well-developed work force, a solid middle class, and a stock market capable of handling enormous investments in Chinese firms. The nation now has to iron out its plans for this new role. And the rest of us are going to have to adjust to those plans, as well. That doesn't mean the transition will be easy, but it does mean that China's stock market problems are not likely to cause a global melt down this year.

And if you are feeling anxious about that 401k balance this morning, take another look at last month's post, What To Do When The Stock Market Drops.

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Curious about GDP? Read more at Investopedia's GDP entry, or check out the GDP growth rates of all the world's economies at Trading Economics.

What To Do When The Stock Market Drops

Just in case you've been reading any of the ominous predictions about our lazy "bull" market or about the panic in China's market, I thought it was a good time to talk about when you should be making changes in your investment account. The short answer to "what should I do when the market drops" is easy—not much. But there are some reasons to do some trading in your account. Here are some things that go wrong in investment accounts—and how often you should check on your accounts to fix them:

1. Lazy cash. You've set up your investment accounts, bought your first stocks or funds and started adding regularly to your account. Great! But if you don't make some kind of arrangement for your new deposits to get invested, all of that money you are adding to the account might as well be stuffed under your mattress. If possible, automate your account to invest new deposits and check quarterly. Otherwise schedule a review monthly or quarterly (depending on how much you are adding) to invest the new cash;
2. Out-of-Whack Allocations. You've created a fantastic portfolio model for your investments and bought all the right percentages of large cap stocks, bonds, small cap stocks, etc..., and now you can sit back and let it work. Except that, as it works, some of your assets will be doing better than others. Over time, this means that one of or two of your asset classes will be growing larger and faster than others. At some point, you will need to rebalance. Notice that this mean buying the kinds of investment that did worse in the market. This is not a mistake—markets frequently cycle so that the investment on the bottom this year is likely to be on top a year or two from now. Check a minimum of once a year up to four times a year to be sure that you are still within range of the portfolio model you originally designed;
3. Change of plans. Sometimes it's your plans that change; other times, it will be a fund manager or company. If you are invested directly in stocks, this may be a case of your chosen small-cap company being bought out by a large multinational. If you are in funds, you may find that the original investment objectives of the fund has changed from investing in a good mix of stocks and bonds to primarily bonds (if you were counting on this fund for your bond allocation, you need to come up with a substitute). At your once a year check, take a look at the investments in your account ("positions") AND click on the name of funds to review their holdings.

And here is the #1 reason not to make changes in your investment account: stock market headlines. Why? Because you came up with a plan for how you want to manage your investments, and if that plan did not account for the ups and downs of every stock market, then it really wasn't a plan to begin with. Don't get thrown off by people trying to create more readers.