The Nature of Capital Markets: Increasing Demand for Services and Products - Research Paper Example

 Gross Domestic Product (GDP) is the total market value of all goods and services produced within a given country in a specified period1. The world faces the greatest fall in the gross domestic product since the second Word War Two. Before financial crisis, world gross domestic product grew at an average of 4% in 2004, 2005, 2006 and 2007. However, in 2008, the world gross domestic product dropped to 2.1%. In 2009, the economy was projected to fall by 2.9%2. The world gross domestic product was estimated to be US$58.07 trillion in 2009. The negative growth experienced in 2009, was the first fall since the Second World War. The global gross domestic product grew at about 3.5% after the Second World War to 2007. The world biggest losers in 2009 were Russia (-7.9%) followed by Mexico (-6.5%), Japan (-5.3) United Kingdom (-4.8%) and Italy (-4.8%). However, there were countries that demonstrated positive growth rate and are china (8.7%), India (6.5%) and Indonesia (4.5%)3. There are factors that influence changes in the growth rate of world gross domestic product. The first one is the global recession. Global recession caused by the credit crunch caused a lot of suffering to the people of most parts of the world. Most people lost their jobs while production and service sectors faced constricted demand. Loss of jobs and demand constriction led to reduction of product and services that caused direct fall in the world gross domestic product. Other factors that contributed to the fall in the world gross domestic product include global warming, natural calamities, desertification and depletion of non-renewable resources. The downward trend is expected to reverse in 2010 when the world is expected to record growth in gross domestic product. If everything works well, economy will improve and Euro zone is expected to grow by 1% (2010) and 1.6% (2011), Japan is expected to expand by 1.7% (2010) and 2.2% (2011) and USA by 2.7% (2010) and 2.5%(2011). The factors that would speed up recovery are improved technologies in the agriculture, financial, medicine, energy and transportation sectors. To realize the growth in the gross domestic product, the world leaders should continue working hard to reduce the impact of financial onslaught and improve their economies from lessons learned from past events. 2- The impact of the financial crisis on the largest economies The financial crisis was one of the most unfortunate events that economies of the world experienced and nearly all countries in the world were affected in one way or another. United States and the European Union were the most affected as compared to Japan. Financial markets in the USA were hard hit and the stocks reduced by 33% in 2008. this is because most people feared for their investments in the money markets and withdrew their investment in fear that the money markets will crumple. International Monetary Fund revealed that USA lost money on toxic assets. Furthermore, most loans borrowed were not serviced between January 2007 and September 2009. The unemployment rates shot as companies downsized while others were closed4. In addition, mortgage lenders went bankrupt because they did not have sufficient money to continue operating. Therefore, several companies and institutions failed, others were acquired under duress while government took over the others. In the United Kingdom, the financial markets were affected. Home prices declined significantly and consumer debt increased to unmanageable proportions. The economy was pushed to recession by the effect of the financial crisis during the last half of 20085 and the public finances worsen because of global financial recession. Japan was a country that felt little from the financial crisis. This is because Japan’s economy is not as exposed as the USA and the United Kingdom markets. However, financial markets were affected in Japan because the stock fell by 42% in 20096. Japan exports declined significantly due to global credit crunch and Japan was pushed to worst recession since the Second World War. UK, USA and Japan generally suffered from the financial crisis. All the three economies suffered from negative gross domestic growth rates. Japan recorded a negative growth of -5.3% on its gross domestic product and United Kingdom experienced a negative growth of -4.8% on its gross domestic product. Generally, the unemployment rates in the tree economies increased. Unemployment rates in Japan climbed from 4.6% in 2008 to 5.8% in 2008 and eventually 9.3% in 2009 because of the financial crisis. It was estimated that 15,0007 estate agents would loose their jobs because of the collapse property sales in the United Kingdom in 2010. The governments and authorities of the three economies instituted several measures to curb the effect of financial crisis and stabilize their economies. The authorities of the three economies instituted measures to curb the effect of the credit crunch. United Kingdom nationalized part of the banking system, set aside money to bail out failing companies and cut taxes. US also set aside money to bail out critical companies in its economies. The above measures eased the effects and helped stabilized the economies of the Japan, USA and UK. 3- The largest markets before and after the crisis occurrence The largest market before and after the financial crisis is the capital market. Capital markets cover the bonds and the stock markets. The world stock market is estimated to be worth US $36.6 trillion and the bond market is estimated to be worth US$ 47trillion8. This indicates that many investors prefer investing in the market because of the benefits it brings. The financial markets rebounded fast and are currently on the recovery path. The fundamentals that drive the capital markets include profitability of the companies listed, conducive macro economic environment, good governance, strong demand and increasing purchasing power of the consumers among many others. The nature of capital markets is very different from other markets. Most companies listed in the capital markets have ever-increasing demand for their services and products. This means that people would continue to consume the product or services even if the economies crumbles to its knees. Such companies listed in the stock exchange are in the energy, pharmaceuticals, minerals and metal sectors. The sectors are important in the economy and authorities will continue supporting them because they are the backbone of the economy. If such sectors fail, the government and governing bodies will also crumble. Therefore, the governments will work hard enough to develop and nurture financial as well as macroeconomic policies that support their sustainability. This very nature has made the capital market resilient and better places to invest. 4- The capital markets recovery and overcoming steps at present and future outlook. The financial markets are considered the most resilient of all the markets in the world. This is because they have the ability to rebound and regain confidence in the market quickly. Though the financial risk are still real and fresh in the minds of most investors, the investors are regaining their risk appetite fast and are demanding more stocks and bonds of some companies in the stock exchange. This is because they understand that it is during the times of distress in the stock market when profits are made. Most investors would like to purchase the stocks when they are still lower to dispose them when the stock market approaches its peak. However, it is important to realize that the market is still fragile and companies as well as governments must work hard to repair customer trust and rebuild their financial resources shattered during the times of financial turmoil. Through ensuring careful management of sovereign risks, supporting credit growth, managing capital inflows and developing policies that will improve liquidity of the investors and consumers, the government and relevant authorities will be able to help the capital markets recover faster9. The first step is careful management of sovereign risks; foreign financial risk should be well managed to prevent financial catastrophe in future. Secondly, the authorities and governments should support credit growth. It is true that the financial crisis experienced were brought about by uncontrolled use of credit cards. However, the credit cards should be allowed because it improve liquidity of consumers and promote sustained demand for goods and services. Therefore, governments through financial authorities should develop better ways of managing credit risks to avoid causing constriction on demand of goods and services produced by the companies listed in the stock exchange. Thirdly, capital inflows should be managed appropriately. Uncontrolled capital inflows increase the rate of inflation in a country causing the price of goods and services to increase. This will eventually affect the purchasing power of the consumers and investors. As a result, citizens may not afford to invest or purchase the goods and services produced. The fourth step to help rebuild the capital markets is improving the liquidity of both the consumers and the investors. The governments should develop policies that ensure that the populations have sufficient money to invest and purchase the goods and services they require. This is because sustained demand of goods and services of companies listed in the stock exchange will lead to good performances for the companies and thus encourage investors to invest in the corresponding stocks. 5- The UK economy overview The United Kingdom’s economy is the leading financial powerhouse in Western Europe. United Kingdom real GDP growth was estimated to be 2.6% in 2007, 0.5% in 2008 and -4.8% in 2009. Since early 1990’s, the government has reduced social welfare programs and the public ownerships. The agricultural sector is considered highly efficient as per the European Standards because it is highly intensive and mechanized. Agricultural sector produces an estimated 60% of food needs in the country and employ’s less that 2% of the total work force. The United Kingdom has stocks of natural resources like coal, natural gas as well as oil resources. However, UK’s reserves of natural gas and oil are declining fast and have begun importing them from other countries. United Kingdom has an estimated labour force of 31.25 million in 2009 according to the CIA. Agriculture employs 1.2%, industry 23.8% and service 75% of the total work force. Agriculture contributes 1.2%, Industry 23.8% and service 75% of the total gross domestic product. According to the estimates by CIA in 2009, government revenues are US$819.9 billion and expenditures are US$1.132 trillion. Some of the agricultural crops produced are cereals, potatoes and vegetables while livestock is cattle, sheep, poultry and fish. The manufacturing and industry sectors produce machine tools, electrical and electronic equipments, automation and railroad equipments. Other items manufactured are aircrafts, motor vehicles, spares, and metals of various uses. Furthermore, the country process chemicals, coal, petroleum, paper and paper products as well as textiles and clothing.10 The figure 1 shows some key indicators estimates of the United Kingdom’s economy Indicator 2009 2008 2007 GDP real growth rate -4.8% 0.5% 2.6% GDP per Capita $35,200 $37,000 $37,000 Inflation rate 2.1% 3.6% - Source: CIA 2010 6- The UK stock market (FTSE 100) performance FTSE 100 comprises a list of one hundred highly capitalised companies in the United Kingdom and has a base value of 1000. FTSE 100 started operations on January 3, 1984. On December 30, FTSE 100 recorded 6950.6. This figure has remained the highest since it was formed in 1984. By the end of September 2008, the estimated net market capitalization of FTSE 100 index was £1,171 billion. The UK stock market (FTSE 100) is always busy. It computes over 120,000 real time indices by the end of each business day. It trades in stocks of companies that operate in over 80 countries11. FTSE 100 covers about 98% investable market capitalization in the world. The lowest FTSE 100 index was experienced in 2003. However, the index rose steadily until 10 September 2008 when it rose above 5000 to close at 5004. The index started falling again after 10 September 2008 because of financial crisis and reached its bottom of 3,932.06 on September 2009. However, FTSE 100 index started improving again after September 2009 and reached 5,753.85 as at the close of business on 26 April 27, 2010. The improvement of the FTSE 100 index continues as the global economy recovers. 7- Two sectors in UK market, which are predicted to be the most promising, and profitable sectors. Investors are keen in choosing sectors to invest their money. This is because they would like to ensure that every pound invested must earn acceptable level of returns. Choosing the areas to invest money is very tricky especially when the global economy is recovering from crisis. There are various indicators of best performing companies. The best indicators stem from the stock exchange realms. Other indicators are the profitability ratios of various companies operating in the economy and the importance of a given sector in the economy. The combinations of the above indicators eventually point to the best companies that investors should invest their money. After careful observation, energy and financial sectors proved to be the best sectors to invest money especially in challenging economic times. This is because the best profitable company in United Kingdom and the rest of the world in 2008 was Royal Dutch Shell that posted a profit of £14 billion12. The other companies ranked top five best companies included Exxon Mobil and BP. All the above sectors are in the energy sector. The Royal Dutch and BP are listed in the FTSE 100 as companies that have high market capitalization. Figure 2 shows net profits of oil companies in the energy sector Company 2009 2008 Royal Dutch Shell £14 billion BHP Billiton £3.8 £9.8 Tullow Oil £19 million £226 million Source: Reuters 2010 Figure 2 shows positive performance especially when the global economy was suffering in2008 because they managed to make profits. The energy sector is key in the economy and will always be reporting positive performances when the economy recovers. However, the challenges with the energy sector are that oil reserves are dwindling. Consequently, cost of production increases and may eat into the profits of the company. The other sector is the financial sector. This comes as a surprise especially when the financial crisis is still fresh in the minds of many investors. Most banks have solid infrastructure and are listed in the FTSE 100 are banks. The banks in the sector are performing quite well despite the shaky economy. Figure 3 shows net profits of the banks in the 2008 and 2009 Bank 2009 2008 Barclays £11.6billion £6.1 billion HSBC £4.5 billion £5.9 billion Lloyds Banking Group £2.8 billion (£6.7 billion) Royal Bank of Scotland (£3.6 billion) (£24.3 billion) Standard Chartered £553.2 £712 Source: Reuters 2010 Figure 3 show that most banks are doing well. In 2008, the world economy crumbled but the figures of the banks are impressive. As the economy recovers, the banks are also expected to do well because improving economy correlates with improving banks performances. Therefore, stocks value of banks will continue to increase because improving global economy leads to increasing profits. The above two sectors are promising as compared to other sectors in the UK’s economy and are better places to invest money. Bibliography: Bis. Org. 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