Global stock indexes are made up of all listed and uncounted company shares of global companies, which have their primary headquarters in other countries, including U.S. States like California, Texas, Florida, and Illinois. As a virus moved from Europe to the United States and then the rest of the world, global stock indexes changed aggressively from a risk-oriented, or “risk-on”, phase, to a “risk-Off” phase, with worldwide stock markets experiencing unprecedentedly sharp bear market selloffs, surrendering historic multi-year support levels, triggering another wave of sell-off pressures and massive market retracement movements.
Why did the global stock indexes experience these dramatic changes? The primary reason is that global equity markets were no longer able to withstand the intense risk-on trading signals, which had become so rampant in late 2020. In fact, it is now possible for the global equity markets to collapse in a matter of minutes. These dramatic market losses occurred during the global equity market crisis, which is characterized by rapid, unprecedented, and simultaneous sell-off and replacement movements, on a global scale.
This crisis was exacerbated by a lack of understanding about the nature of the underlying global equity markets, as well as an increase in risk-on trading signals that resulted in a number of major global market index funds that were heavily leveraged and negatively affected. The most notable example was the Global X mutual funds, which suffered heavy stock market losses that nearly wiped out the fund in just three days.
Now let’s look at the major causes of the Global stock indexes’ drastic changes, and how we can avoid similar problems in the future. First, investors should understand that the most common cause of sudden change in global stock indexes is a lack of diversification across global asset classes. Second, it is essential to understand the difference between the term “Diversification” and the term “Risk.” Finally, investors must be aware that the term “Diversification” is an umbrella term that includes asset class strategies, while “Risk” is a method of evaluating and planning for the risks associated with a particular portfolio strategy.
Risk is the ability of a portfolio to grow over time, while “Diversification” is a measure of the ability of a portfolio to grow without becoming too highly concentrated. When risk is high, the risk-on factors causing the loss of capital are very high and the risk-reducing factors, such as interest rates, are not so high. This results in very rapid stock market losses due to the loss of liquidity, and margin calls. When a portfolio is extremely concentrated, it is also considered to be a high-risk portfolio. And when that portfolio is highly diversified, it has no “innocent assets” to compensate for losses due to interest rate movements.
Global stock indexes were subjected to a number of risk-on signals, which became more prevalent following the start of the global stock market crisis. For example, the European debt crisis in the fall of 2020 triggered a severe sell-off in European equities that devastated large European companies that had been heavily leveraged and heavily exposed to European government bonds. As an example, Spanish government bonds experienced a 25% sell off in a matter of minutes as European governments began to default, which triggered large losses in the European bond markets. Large global bond markets experienced a similar trend. This is known as a global “default event,” which occurred after a global default, or economic default, triggers a domino effect in markets worldwide, including in the U.S. equity markets.
A number of analysts attributed the losses to the global default event on European government bonds, particularly, the United Kingdom, and the European government’s failure to act quickly and effectively to halt the sell off in the European stock index indexes. The United States also suffered a significant drop in its stock index values due to the global default on European government bonds, but did not experience the widespread and large decline experienced by European governments. The loss of European governments as well as a lack of European government bond purchases reduced liquidity in the stock market and caused a further decline in global stock index values.
Because of the lack of diversification in the stock index, a number of analysts have theorized that the losses observed in the U.K. were due in part to the relative stability of the U.K. economy. Another possible cause is that investors mistakenly invested in the UK stock market due to the fact that the United Kingdom was still largely under the control of a government and a favorable banking system that were highly stable. In contrast, investors failed to diversify their portfolio across other asset classes due to the widespread uncertainty regarding the health of the European economy, or any other country’s economy.