The mood in stock markets around the world in 2016 has been jittery at best and at worse, close to a panic. The Dow Jones Industrial Average is down 8.33% year-to-date while Shanghai is down more than twice that, dropping 19.85% since December. The Japanese Nikkei has plummeted by 15.65% while India’s Sensex is trading 10.46% lower year-to-date. The Hang Seng and FTSE have dropped by 12.74% and 6.02%.
And yet, American job statistics are strong, and there is the possibility that oil producing nations might agree to end their prisoners' dilemma that has kept production high and prices low. How much longer will fear continue to drive markets? Here are three reasons the worst may not be over.
1) Tumbling Oil
Oil has been making things slippery all around. The continued fall in oil prices is a pain for oil-dependent economies pushing them into a hard financial corner with massive deficits and shrinking budgets. Companies engaged in the sector are facing huge losses due to the slide in oil prices. Output, work force, and other expenditures have all been slashed. While low oil prices have advantages for many, the problem of oversupply has overshadowed all positives.
The rigidity of OPEC on the issue of curtailing oil production has led to a persistent over supply situation. However, there are indications that OPEC is ready to cooperate on the subject. if this does happen, the tumbling prices of oil would get some support and so will bleeding companies. (For more, see: Global Stocks Drop as Oil Rout Continues.)
2) Possibility of NIRP
The stance of central banks, especially the Federal Reserve, is being scrutinized very closely. Japan has already adopted a negative interest rate strategy in an attempt to stimulate the economy. Bond yields have turned negative, and yet the effects of Abenomics have been minimal.
On the question of whether the Fed would consider implementing its own negative interest rate policy, the U.S. Fed Chair Janet Yellen said they aren't "off the table": "In light of the experience of European countries and others that have gone to negative rates, we are taking a look at them again because we would want to be prepared in the event that we would need (to increase) accommodation. We haven't finished that evaluation. We need to consider the institutional context and whether they would work well here. It's not automatic.”
Although the Fed reiterated that it remains flexible in the approach it takes, speculations about its future course have added to worries, especially for the banking sector, which is already one of the worst hit sectors in 2016.
3) China Woes
“China sneezes, the world catches a cold” captures the effect of China on the global stock markets. The mainland’s economy growth touched a 25-year low in 2015 as its GDP expanded by 6.9%. Beijing has set its economic growth projection range at 6.5%-7% in 2016.
According to Xu Shaoshi, Chairman of the National Development and Reform Commission (NDRC), “Downward pressure on the world's second largest economy will remain in 2016.” The cooling down in asset prices, shaky stock markets and a mild economic growth outlook for China have prompted investors to shift to dollar-denominated assets at home and abroad, a process which has resulted in a depreciation of the yuan and capital outflows.
To stem the flight of capital, Beijing has put in place a number of mechanisms, from efforts to curb short selling and currency speculation to easing of foreign investment inflow into the mainland, to selling dollars to support its currency. China’s forex reserves dropped by $513 billion for the first time in history in 2015. The lack of clarity about what exactly is happening in China is keeping everyone edgy. (Read, 4 Ways China Influences Global Economics.)
The Bottom Line
While the broader economic fundamentals are intact, collapsing asset prices and some weak reports on economic indicators have triggered ideas of an impending recession. For investors to shake off their pessimistic mood, the drumbeat of news must turn positive.
For instance, remarks by Mario Draghi on Monday that he would not hesitate to take fresh action to boost Eurozone growth and inflation rallied European markets. While the broader issues remain, positive news coming in the form of economic data or statements by regulators may help to calm the markets and restore confidence.
