Are global markets melting down?
Photo: Cai Tjeenk Willink. Source: Wikipedia
Yesterday felt like one of the most bizarre days I’ve seen in the 30 or so years I’ve been following the markets. I’ve seen selloffs, panics, corrections, and crashes. This wasn’t like any of them. It had its own peculiar logic.
It started out with some follow-through from last week. Since the sell-off started with China, it made sense that China would lead in any further market action. When I woke up, I noted that Dow futures were down a couple hundred points—bad, but within reason. Then it got crazy. Futures went down dramatically, the market opened down, then we rallied. We were still down a couple hundred points, but it felt like we were up, sold off into the close. In the end, the market had one of its biggest losses ever, in terms of absolute level—despite the lack of negative economic news. In fact, the US economy has been doing fine, even if it’s not booming.
Here’s my take: three different strands are impacting global equities. First, the sell-off in oil continues to rattle. Saudi Arabia has been pumping as much as possible, pushing oil prices lower. Global demand is up, but it hasn’t grown fast enough to absorb the excess supply. The resulting excess inventory is weighing on the market. Folks are questioning whether lower oil prices are simply a result of over-supply, or if there is something else going wrong.
Second, China’s currency devaluation took most observers by surprise. They had held the Yuan steady through two successive crises—the Asian Contagion in 1998 and the Financial Crisis of 2008. But Chinese authorities want the Yuan to be part of global capital flows, and for that they need a freely traded currency. So after July’s exports were reported down 8% from a year ago, they announced a modest drop in the Yuan’s target level. After all, that’s what forex traders would do. But the Chinese stock market has panicked.
Finally, the Fed’s long-expected interest rate party has been the talk of the market for—well, it feels like forever. Rising interest rates can affect capital markets, economies and equities in unpredictable ways. At a minimum, they increase the discount rate at which to value future cash flows. By itself, this would lead to lower equity market valuations.
Taken together, these three factors led to yesterday’s sell-off.
These all came together just when we had a late-summer lack of liquidity. Many major market participants are away from their desks right now. The beach can be beautiful in August, even if it its crowded. The result has been our summer swoon.
What will happen next is anyone’s guess. In the short-run, the market will be jumpy. Volatility breeds more volatility. But in the long run, the stock market will go up because economies grow. One thing is certain: six months after the market turns, everyone will claim to have called it.
Douglas R. Tengdin, CFA
Chief Investment Officer