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Explained: Global stock market rout

  • Tumbling stock markets in emerging nations this year were recently joined by the US and Europe markets that saw a sudden drop
  • The strong US dollar has been a major catalyst for emerging markets’ plunge so far
  • Raising of rates by the US central bank (which actually pushed up the dollar) contributed to the slide in both advanced and developing economies recently
  • The most pervasive trigger, however, has been the looming trade war between China and the US
The sudden stock market selloff this week saw major indices erase gains to reach new lows

Stock market performance this year, up until a week or two back, had been characterized by two distinct trends. First, emerging market stocks, spanning regions of Asia Pacific, Africa and Latin America, tumbling almost USD4.5 trillion owing to massive sell offs. Second, developed-market equities across Europe, Japan and the US surging with investors preferring them over developing nations’.

The divergence in opposite direction was in large part due to a resurgent dollar that aggravated the woes of stock markets in developing nations.

As the greenback got mightier owing to the US Central Bank, known as the Federal Reserve, hiking rates (it refers to the interest rate at which a commercial bank lends funds maintained at the Fed to another bank overnight) eight times since 2015, investors dumped developing nations’ stocks to lap up US stocks and assets such as Treasury Bills.

The same investors flocked to emerging markets when the Federal Reserve and European central banks kept rates at near-zero levels between 2007 and 2014 to retrieve their economies from the depths of the subprime crisis. This led to more dollars floating in the economy as there was little incentive to save. This also egged consumers to borrow for homes, cars and expensive electronic goods. With the subsequent demand increase, companies borrowed for expansion too.

Such an expansionary monetary policy paid off as the US and European economies rallied eventually on the back of manufacturing growth.

Assured the economic mechanism is on a firm footing, the Fed then began raising interest rates. Investors who once bet big on Asian and South American stocks that remained unaffected by the subprime-triggered financial crisis shifted focus back to Europe and North America.

That narrative playing up until the start of the third quarter this year has now suddenly changed. The past one week saw the US and Europe markets embroiled in a rout too. Ironically, the Fed’s rate hike was one of the reasons.

We take a closer look at what caused the worldwide selloff apart from the strong dollar.

Emerging markets

In Asia Pacific, Japan which was an outlier for long got sucked into the bear market too, with China leading the way. In fact, China’s has been one of the worst performing stock markets in the world this year. While the strong dollar has been a key trigger for it, trade war fears have been adding fuel to the fire. So far, the US has imposed sanctions to the tune of USD50 billion and is contemplating another USD200 billion worth of sanctions. China has retaliated too and going forward plans to throttle the tech-sector supply chain, the lifeblood of the biggest US companies.

But given the double whammy of rising dollar and trade tensions, the China market has taken maximum beating. Investors pulled out from export-focussed mainland companies to park their money in the US stocks. The Shanghai Composite, which is down almost 20 percent this year, hit its lowest in four years.

Meanwhile, weak economic fundamentals in nations of India, Philippines, Myanmar, Pakistan, Taiwan, Indonesia and so on, have resulted in their major indices plunging. Inflation, large trade deficits (it occurs when import bills exceed export revenues) and budgetary deficits has kept their currencies weak and spooked investors.

So much so, Asia stocks hit a 17-month low very recently. MSCI’s broadest index of Asia Pacific shares outside Japan, which is the region’s broadest measure reached its lowest since May last year.

Similar situations have prevailed across emerging economies in other parts of the world as well.

For example, double-digit inflation, large trade deficits owing to buying more than it sells and heavy reliance on foreign debts has weakened the Turkish currency Lira. As Turkish companies struggle to repay the foreign currency debts faced with a debilitated currency and a strong dollar there has been a flight of capital from its markets.

Similarly, South Africa markets stared at a 25 percent loss this year because of poor performance of industrial and mining stocks.

South American nations also succumbed to the market selloff. Take for instance Argentina. Just like Turkey it has been bogged down by dollar borrowing. Around USD253.7 billion in external debt is being supported by only UDS51.3 billion in foreign exchange reserves in the nation. This is even worse than Turkey’s condition. Naturally the Argentinian peso has seen a freefall. Then of course there is the small matter of a resurgent greenback and crude oil prices.

The US and the rest of the west

Wednesday this week marked a definitive rout though there was no sudden trigger. The US’s war against Chinese goods and raw materials simply backfired on it. This is because it has raised serious concerns over global growth outlook with tech companies’ revenues projected to bear the maximum brunt.

Another reason for the unsavoury turn is the rise in the US interest rates that makes it expensive for businesses to borrow money to fund operations and expansions.

Besides, higher bond interest rates – 10-year treasury note yields rose the most – lured potential buyers from the volatile stock market. With the booming US economy, investors chased stocks and corporate bonds. This dampened demand for government bonds such as Treasuries thereby driving up their yields (bond prices and yields move in opposite direction). As yields marched higher, many decided to park money in bonds, ditching stocks.

Hence, Wednesday saw the Dow Jones Industrial Average giving up almost 3.2 percent. The tech-heavy Nasdaq Composite fell almost 4.1 percent, its worst fall after the Brexit vote in June 2016.

Trump, of course, promptly passed the buck to the Federal Reserve whose contractionary policies he blamed for the unprecedented slump.

The contagion spread to Europe where major indices tanked too.

But many feel the correction was par for the course as the stock markets had been rising too fast. Since Wednesday, when the western markets took a hammering, losses have been reversed to an extent. However, volatility remain on the cards in the near term at least, predict market pundits.