Ever since 2016 started we have seen a steady decline in the global financial markets. It started with China on the first trading day of the year, when the CSI 300 Index immediately opened lower and triggered circuit breakers that forced the market to shut down. Given the interconnectivity of today’s global economies, a decline mindset quickly spread to global financial markets and now it doesn’t seem to be stopping.
But why should U.S. equities also suffer when our economy is turning the corner when compared to China’s which is slowing down? My view is that these two economies are very different and eventually they need to delink themselves.
China’s problems stem from the fact that the rebalancing of its economy has not been supported quickly enough by government financial reforms. The ambitious attempt to shift China’s economy from one based on infrastructure and industry to a consumer and service-oriented economy has come at a price: insurmountable debt in the traditional steel and coal industries.
Economic rebalancing in China needs to be combined with the development of a robust financial system and a solid capital market that can serve as a cushion for this drastic change. This rebalancing has not happened, however. Quite to the contrary, the monetary authorities have sent confusing messages that have caused some disillusion in the markets. This is unfortunate because the added uncertainty and volatility has turned the clock backwards in terms of China’s economic rebalancing goals.
Meanwhile, the factors underlying the falls in the stock markets of the U.S. and other advanced economies are quite different. Originally, the falls were the fear of the spillover effect of global economic weakness. But that fear now has been amplified by the realization that central banks can no longer support additional injections of capital – or free money – as the markets continue to fall.
Over the past couple of years, advanced countries’ stock and property prices rose much more quickly than had been expected but it has been unclear whether those investments were reaping positive financial results when the economy was only growing by single digits.
With the first lift-off in interest rates by the Federal Reserve last December, we will start to see whether the current stock price levels can prevail. It may be healthy for some air to be taken out of the markets, but eventually prices will settle into their natural equilibrium with the right returns.
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