Washington, DC; January 24, 2016: When one looks at the global economy, and what leading forecasters think it will do in 2016, things look to be in a reasonably solid state. The world economy will grow 3.4 percent this year, economists at the International Monetary Fund projected last week, up from 3.1 percent in 2015. Private sector forecasters mostly have similar expectations.
If you look only at global financial markets, it’s been terrible, gloomy, and falling steadily, and is beyond one’s understanding. Stock, bond and especially commodity markets have swung in ways that suggest this is a perilous time, but the cause is puzzling. In the first three weeks of the year, global financial markets swung in ways that suggest this is a perilous time. “As the US stock market continues its wild ride mostly downward and the price of oil dips below $30 a barrel this week, we highlight some of the analysts trying to make sense of the indicators. Are we headed for another round of global economic decline or is this volatility temporary?” Carla Thorson, Senior Vice President, Programs, wrote.
Their volatility and direction are consistent with the prospect of a new crisis or global recession. The main European stock exchanges also slid to a 15-month low. Markets in Dubai closed at a 28-month low, while in Japan shares fell to their lowest level since October 2014. Many markets are now in so-called bear market territory – a fall of 20% or more from their most recent peak.
At one point, the benchmark Brent oil index was down more than 5%, while US oil fell almost 7%, fueling fears about the impact on economic growth and falling revenues earned by oil-rich nations. Since the FTSE 100’s all-time high of 7,103.98 points on 27 April last year, the total market capitalization of the index has fallen by £396bn. Top emerging market shares and currencies were also caught up in the turmoil, with the Russian Rouble hitting a new record low of 80.295 against the dollar.
Some observers think that many markets were riding for a fall. Asset prices were pumped up by ultra-low interest rates in the developed world and also by the central banks that have engaged in quantitative easing, buying financial assets with newly created money. That happened with shares, with bonds and with commodities. For commodities the boom is well and truly over, partly due to the slowdown in China and in the case of oil mainly due to plentiful supplies.
In the past, when the stocks fell, there were clear reasons, In the summer and fall of 2011, markets were tumbling on fears that the European Union using the euro currency would dissolve; in 2008, it was fears that the global financial system would collapse; in 2000 it was on the realization that stock prices, especially for tech companies, had gotten out of line.
Many policy makers around the world are finding it hard to tell a simple story about what is driving them. It could be that the markets are moving according to their own internal logic, driven by money managers’ psychology, with their habitual toggle between fear and greed turning back toward the former. More frightening: The markets could be pricing in some darker facts about the outlook for the world that economists don’t fully understand.
The recent market swings are “puzzling,” writes Olivier Blanchard, until recently the chief economist of the International Monetary Fund and now a senior fellow at the Peterson Institute for International Economics. As a general rule, if Mr. Blanchard is puzzled about something involving global economics, you probably should be, too.
According to analysts, the price of oil is where most of the action is, with West Texas Intermediate Crude trading below $27 a barrel last week, down from around $37 at the end of December, $60 in June and $100 in mid-2014. The broad S.&P. is down 9 percent so far in 2016, and stock indexes in many emerging economies are down even more. Bond and currency markets point to economic troubles in oil-producing nations. The Dollar has been on the rise against most currencies. The Canadian dollar is down 19 percent against the United States dollar since May.
The drop in oil price creates vast numbers of winners in India and China and gives oil-dependent economies like Saudi Arabia and Venezuela an urgent reason to embrace reform, according to the author. Collapsing revenues could bring instability to fragile parts of the world. Cheap oil also has a green lining as it drags down the global price of natural gas, however in the long run, cheap fossil fuels reduce the incentive to act on climate change. The Economist wrote that the benefits of such ultra-cheap oil still outweigh the costs, but markets have fallen so far that even this is no longer clear.
China’s once-blockbuster economic growth does seem to have slowed a good deal, though it’s not clear why that should have enormous effects outside China. Oil prices are down so much that profits of oil companies will suffer mightily, and some will surely go bankrupt.
There’s a more complex story in which global banks are sitting on loans for oil exploration that will go bad, creating losses in the financial sector that could cause a pullback in lending more broadly, a risk described by researchers at the Bank for International Settlements in 2015. In this scenario, loans for oil exploration could be what subprime mortgages were in 2007 — a trigger that reveals bigger problems in the financial system.
One piece of evidence for this theory: Bank stocks have fallen even more in 2016 than the stock market over all, implying that investors believe banks did a little too much oil-field lending, though certainly this won’t amount to the kinds of declines and major troubles of 2008.
Another possibility is that this sell-off reflects the unwinding of “herd” behavior among global asset managers, who piled into similar investments during the 2009 to 2014 stock market rally and are now racing to unload the same high-yield bonds, emerging market stocks and energy investments all at once. In this telling, the moves in market prices reflect more the psychology of money managers than fundamental information about the state of the global economy.
Analysts says, financial markets are always more volatile than the underlying economy; the stock market has predicted nine of the last five recessions, as an old line often credited to the economist Paul Samuelson has it. It was certainly true in the fall of 2007, when the stock and bond markets were more prescient about the looming recession in the United States than the consensus view of economists.
In The Atlantic, Bourree Lam wrote about the consequences of the unequal growth. Acoording top him, since the financial crisis, there is a renewed, more urgent focus on the issue of inequality at the World Economic Forum. The stated goal of the conference is “improving the state of the world” – it is evident that there are several reasons for pessimism about the world economy. However, nonprofits, activists and even the pope encourage Davos participants to address inequality. Oxfam’s yearly report on inequality is grimmer than ever: the wealth of the 62 richest people in the world have about the same amount of money as the poorer half of the world.
The challenge for investors is to determine whether the stock market moves of the last few weeks represent the rational kind of fear or the irrational kind of fear, and we probably won’t know the answer anytime soon. Clearly there are some troublesome developments and the IMF has a warning: “If these key challenges are not successfully managed, global growth could be derailed.”