It has been a perfect storm for global financial markets. But the components of the storm are so varied that there will be no unity of opinion on the aftermath.
Some of those components may be oversold others merely at the start of a long malaise. If there is a common denominator it is exaggeration of China’s role. Although China remains a partly closed economy, foreign markets have massively over-reacted to Beijing’s moves – for example the Aug. 25 cut in interest rates – saw New York briefly rebound by 2 percent until it was deemed more evidence of weak Chinese demand and suggesting further currency devaluation.
The components are:
- The unsurprising end of a credit- and official exhortation-fueled China stock boom focused particularly on secondary and supposed tech stocks.
- The continued decline of oil and commodity prices. That is more the result of supply increases than demand falls but China got the blame and stocks and currencies of commodity exporters fell.
- China’s modest devaluation set off a fears of a global currency war which would damage all economies. So-called emerging market currencies have suffered again even if they have been beneficiaries of low commodity prices.
- Generalized fear that China’s days as leader of world growth are over and hence the world which has been benefiting from Chinese demand is in for harder times. Deflation looms almost everywhere, a particular hazard to markets used to inflation and low real costs of money
- The prospect of higher US (and other) interest rates. This is deemed to be bad for stocks generally and especially bad for emerging markets which have been fueled by borrowed dollars.
- The strong dollar and its impact on earnings of US companies, exposing the unrealistically high valuations of the US market.
- The failure of Japanese Prime Minister Shinzo Abe’s policies in Japan to stimulate demand, which have pushed stock prices to the point where reaction only needed a spark
- Europe’s papering over of the Greek crisis plus a weak currency, which has produced outsized gains on once-depressed Euro markets, which invited reaction.
So there are interlinked themes but plenty of room for the future to be more divergent.
Take China. It is abundantly clear that China is not growing at anything like the 7 percent officially claimed and that it should be content to settle for a consumption-led 4-5 percent. That is the best that can be expected from an economy saddled with so much domestic debt and over-investment in low return projects.
Exports are no longer an option as global demand is weak and a major devaluation would spark retaliation and more market turmoil. Many Chinese stocks have been prevented from falling by suspensions and official support. These have further to fall given that the Shanghai index is still above a year ago. That said, however, some of the big, boring state-owned behemoths are no long looking expensive, at least by their prices in Hong Kong, where discounts to mainland A shares are still substantial. Selective bottom-fishing may be advised for those who can stand more short-term volatility and perhaps another big sell-off.