From London to New York, Shanghai to Singapore, Tokyo to Seoul; the world’s major bourses have taken a big hit this past week, major market turmoil with the metals also getting a pounding. What is going on?
The sell off began on Tuesday in China, spreading to other Asian countries like South Korea, Japan, Singapore and Malaysia. When Europe woke up, the wave hit the bourses in the U.K., Germany and France, along with those in the continent’s other major economies.
When the U.S. woke up, there was naturally a panic, and losses were heavy. Things looked a little better on Wednesday, but it as far from a significant rebound. Today, losses have continued in the major markets of Asia, Europe and North America. Most metals have followed a similar trajectory.
Markets are bound to undergo periods of volatility as part of the normal course of events; but can this week’s turbulence be explained away as simply one of these periods, or are we dealing with something more troubling?
Given that the sell off started in China, it seems sensible to look for answers there first.
Chinese stock markets have had an extremely strong run recently, and it is not unreasonable to suggest that valuations may have started start to look top heavy. Investors who are sitting on big profits will always be quick to take money off the table if they sense their profits are at risk, as they inevitably are after a long period of solid gains, and this may well have been what happened in the Chinese markets on Tuesday.
There was also reason to suggest that profits needed to be locked in. Speculation was rife that the government in Beijing was about to implement a round of measures to try and cool the Chinese economy. This speculation has now been dampened down somewhat by the government, but nevertheless it makes a plausible trigger for Tuesday’s falls.
It would be wrong to argue that there is a significant internal threat the health of China’s economy, and it is important to bear in mind that China’s stock markets are much less closely related to the state of its underlying economy than is the case in the U.S. or Europe, partly thanks to a higher proportion of unquoted medium to large enterprises in China and partly thanks to a more complicated and opaque financial system.
In the U.S. however, talk has been building that economic growth is soon to suffer, particularly if mounting inflationary pressures lead to interest hikes. The continuing overvaluation of the dollar and its inevitable collapse also represents an enormous risk to the U.S. economy. As the Chinese economy exports huge quantities of merchandise to the U.S., this week’s pain could at least partly be a manifestation of fears over the outlook for a major export market.
A third explanation for the knock taken by world markets lies with the volume of speculative funds washing around the globe today. The much talked about yen carry trade, current account surpluses in Asia, high oil prices and the burgeoning ranks of the hedge fund industry have created a climate where liquidity is not in short supply. The portion of that liquidity that is used for pure speculation, as opposed to long-term investment, has injected an element of jumpiness to financial markets that did not exist before.
Jim Trippon, editor-in-chief of the China Stock Digest, which bills itself as America’s No. 1 advisory on Chinese equities traded on U.S. exchanges, broadly agrees. Speaking with your correspondent, Jim identified the three main factors he thinks sparked the sell off in China on Tuesday:
- A speech made on Monday by Alan Greenspan, ex-chairman of the Federal Reserve, suggested strongly that the U.S. is heading for a recession, which would have knock-on effects in China and elsewhere.
- Strong gains in Chinese stock markets in 2006 leading to a bout of profit taking this week.
- Talk of government measures to slow the Chinese economy and cool down its stock markets.
In conclusion, stock markets almost everywhere, not just in China, saw strong gains in 2006. The effect of an outbreak of profit taking, amplified by the presence of fleet-of-foot speculators, is the most likely reason for the present state of upset.
Therefore, this week’s outbreak of profit taking need not mean a red light for the world economy.
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Photo credit: Alex E. Proimos via Visual hunt / CC BY-NC
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