A Brutal Week in Markets, But What Comes Next?

Investors around the world will be looking to next week with some anxiety as they lick their wounds. A brutal week of losses was accentuated by an unpleasant close for the U.S. stock markets that saw the Dow Jones Industrial Average plunge more than 500 points (3 percent) for the day and taking it into correction territory, or down more than 10 percent from its last high. The losses for the week were accompanied by even larger ones elsewhere, including emerging-market currencies and oil.

In assessing what lies ahead, investors would be well advised to consider six major factors that have brought markets to this uncomfortable point.

​1. Unlike some previous episodes — including the 2008 global financial crisis and the 2013 “taper tantrum,” as well as those associated with euro-zone concerns — the catalyst for this market retreat came from outside the developed world. It largely reflected concerns about slowing growth in emerging economies (China in particular, but also Brazil, Russia and Turkey), compounding the entrenched economic sluggishness in Europe and Japan.

​ 2. Global growth concerns were intensified by the struggles policy makers in emerging markets are having in stabilizing their domestic finances and limiting further damage to their economies. Again, China is under the spotlight given questions about whether government interventions have stabilized its domestic stock market.

​3. The impact of lower global growth was particularly painful for other markets that already were under pressure from developments on the supply side. As such, the plunge in oil prices highlighted the extent to which the market’s new de facto swing producer — the U.S. — doesn’t play the same role that the Organization of Petroleum Exporting Countries did at the height of its power.

​4. Exports from emerging economies, particularly raw materials producers, are most at risk from the combination of slowing growth and lower worldwide commodity prices. Accordingly, the market carnage was greatest in emerging-market currencies, pushing losses to levels beyond what was experienced during the global financial crisis in 2008. And these markets are technically the most prone to overshoot, with significant and adverse spillover effects on other markets.

​5. Because some portfolios are designed to unwind during turmoil and heightened volatility, financial markets slipped into the destabilizing grip of contagion — with the risk of overshooting. The VIX, commonly referred to as the fear index, soared. Richly valued stocks, particularly in the tech industry, were battered. This inevitably undermines the buy-on-dips mentality, leading investors with dry investing powder to wait on the sidelines for now.

​6. There is less confidence that central banks — repeatedly the markets’ best friends — can act as immediate and effective stabilizers. Moreover, the Federal Reserve’s minutes released on Wednesday — in which the central bank had no choice but to seem wishy-washy –highlights the policy challenges in a world that has come to over-rely on central banks. Indeed, the cult of central banks has driven a wedge between asset prices and  economic fundamentals.

Yes, the People’s Bank of China could loosen monetary policy; and, yes, the Fed could hold off hiking rates in September. But the impact on global growth would likely be limited unless these steps are accompanied by a more comprehensive policy response. Otherwise, prices need to fall a lot more before wary investors get off the sidelines.


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