Expect more ups and downs on global stock markets

News on Aug 21 of China's industrial production - a key barometer of manufacturing - dropping to its lowest point since the global financial crisis kick-started the stock market rout. As more economic data about China, the US and the euro zone is unv
News on Aug 21 of China's industrial production - a key barometer of manufacturing - dropping to its lowest point since the global financial crisis kick-started the stock market rout. As more economic data about China, the US and the euro zone is unveiled in the upcoming quarters, and as developments in Greece unfold, markets will likely go through more ups and downs.PHOTO: REUTERS

Anyone taking the briefest glance at a newspaper in the past couple of weeks would have noticed doomsday headlines blaring out.

Financial markets appear to be on the verge of a meltdown although they staged a creditable recovery towards the end of last week.

But in such a volatile situation with stocks plunging, and currencies - notably Asian ones - sinking to record lows and commodity prices falling so hard economists call it a "death spiral", it is enough to make anyone wonder if they should cash out all their assets and shove the haul under their bed.

Before making any hasty moves, it helps to first understand what is causing all this turmoil and whether it really is time to panic. And the key to understanding it is China.

SHOCK DEVALUATION

This is how it all began. On Aug 10, China's central bank announced that it would devalue the yuan against the US dollar.

It did this by changing the way it calculates the daily value of the yuan against the greenback. The regulator said it was a one-time fix to allow the yuan's exchange rate to be driven by market forces and help the yuan gain traction as a global currency on a par with the US dollar, euro, yen or pound.

But economists and investors interpreted the move differently - as a sign that China's economy was slowing down so sharply that Beijing had to take the drastic step of weakening the yuan so as to make Chinese exports cheaper and more attractive. As if to further confirm investors' fears, the central bank devalued the yuan twice more in the following days, causing the currency to depreciate by over 4 per cent against the US dollar in just three days - the biggest drop in decades.

Given the close trade links China has with many Asian economies, investors worldwide began selling Asian stocks and currencies in the expectation that an economic slowdown in China would drag down growth elsewhere in the region too.

Countries such as Indonesia and Malaysia had until now been profiting from a booming China by selling oil, raw materials and other commodities there. A flagging Chinese economy would mean weaker mainland demand for such materials, and so a fresh sell-off of commodities began.

WEAK MANUFACTURING NUMBERS

As investors absorbed the implications of slowing Chinese growth, financial markets muddled along over the following two weeks.

But then came news on Aug 21 that China's industrial production - a key barometer of manufacturing - had dropped to its lowest point since the global financial crisis.

That's when all hell broke loose.

Shanghai stocks dropped by over 4 per cent that day, leading losses across Asia. Singapore shares fell 1.3 per cent, sinking below the psychologically key 3,000-point level for the first time since February last year. Hong Kong retreated 5 per cent and Japan declined 3 per cent.

Europe and the United States quickly followed suit. By the time markets closed in New York, the Standard & Poor's 500 index was down 5.8 per cent for the week, its worst weekly slump since 2011.

The grim mood came back full circle to Asia when markets reopened on Monday. Shanghai stocks led the way, plummeting 8.5 per cent. Other Asian indexes sank to three-year lows, with the Straits Times Index down 4.3 per cent, its worst one-day plunge in seven years. By the end of the Asian trading day, media outlets around the world were calling it "Black Monday".

When Europe woke up later that day, its markets immediately fell into a deep funk too, diving 5 per cent.

The gloom infected Wall Street, with the Dow Jones Industrial Average nose-diving a record 1,000 points just minutes after opening.

In short, global stock markets had turned into a battlefield.

Commodities too bled anew, with oil prices hitting six-year lows.

NO REPEAT OF 1997

Amid the chaos, the consensus among economists is that no, this is unlikely to be the start of another Asian financial crisis. Asian economies are stronger today, they say.

One trigger of the 1997 crisis was that the United States sharply raised interest rates, which suddenly made it more costly for Asian economies to finance their US-dollar debt, which they had been taking on for years to drive economic growth.

When US rates rose, "hot money" from global investors that had poured into Asian markets for years suddenly flowed out. Asian currencies and asset prices collapsed.

Asian central banks had to empty their foreign exchange reserves to shore up their exchange rates, which they had pegged to the greenback, bolster asset prices and pay off their external debts.

Investors have been expecting a similar scenario. Since last year, many economists have been predicting the US Federal Reserve will raise interest rates next month.

Hot money has been steadily flowing out of the region over the past year. According to NN Investment Partners, the 19 largest emerging markets had nearly US$1 trillion (S$1.4 trillion) of outflows in the 13 months to July 31.

And so it had already been quite the volatile year for emerging markets. Then, China suddenly devalued the yuan - only speeding up outflows. One consequence of this, and the ensuing market turbulence, is that the Fed is widely expected to raise rates only much later this year. Economists now predict December. In any case, it is unlikely to lead to another Asian crisis.

Asian central banks have cleaned up their books, made their exchange rates more flexible and have much less external debt today.

They also have larger foreign currency reserves, which would help to cushion against a rise in interest rates or a fall in asset prices.

Also, DBS Bank equity strategist Jason Low noted that even when US interest rates rise, they will do so very gradually.

Valuations of Asian shares are also lower now than just before the 1997 crisis, he added, with no stock market bubble threatening to pop.

MARKETS ARE IRRATIONAL

Of course, China's economy is indeed slowing, and this will affect many other Asian economies, including Singapore, which have close trade links with the mainland.

But this is not news. There has been evidence of a Chinese slowdown since the beginning of the year, noted Mr Juan Nevado, a portfolio manager at M&G Investments.

"So it seems more that perceptions, rather than fundamentals, have changed following the People's Bank of China's surprise move to devalue the currency, as well as an element of price-driving-price," he said in a note.

Investors can take time to react. The complexity behind global economics and finance becomes distilled into a single story, causing sudden swings in sentiment to escalate, he said.

SO WHAT NEXT?

Despite the severity of Black Monday, markets around the world have already bounced back. Wall Street closed higher last Friday, with the Dow Jones Industrial Average, S&P 500 and Nasdaq all chalking up gains of 1 per cent or more for the week.

Asian shares also ended Friday higher, with the MSCI Asia-Pacific Index close to erasing all the losses from earlier in the week.

But analysts still expect more volatility ahead, especially as China's economies woes are far from over.

Meanwhile, the economic outlook for the rest of the world is patchy as well.

Although the US has surprised with better-than-expected economic growth in the second quarter, Europe's recovery has been slower and less convincing, and Greece's debt crisis is yet to be fully resolved.

As more economic data about China, the US and the euro zone is unveiled in the upcoming quarters, and as developments in Greece unfold, markets will likely go through more ups and downs.

So while it may not be time to stuff all your money under your mattress, neither is it a wise time to be making big bets on investments.

A version of this article appeared in the print edition of The Sunday Times on August 30, 2015, with the headline 'Expect more ups and downs on global stock markets'. Print Edition | Subscribe