What’s be­hind the global stock sell-off?

The Pak Banker - - OPINION - Robert J. Sa­muel­son

CAP­I­TAL­ISM has al­ways been an epic strug­gle be­tween risk and re­ward, and the eas­i­est way to un­der­stand the present tur­moil in world stock mar­kets is to rec­og­nize that the two have re­versed. Risk has gone up, and re­ward has come down. In­vestors have re­acted by sell­ing. Fear tri­umphs over greed. This, of course, in­creases risk and sell­ing. It's an old story.

It may also be mis­lead­ing. De­spite the sell-off's sever­ity (in 2016, U.S. stocks have dropped 7.4 per­cent and lost $1.8 ?tril­lion in value, says Wil­shire As­so­ciates), many econ­o­mists doubt it her­alds a re­ces­sion. "Mar­ket tur­moil [is] not jus­ti­fied by eco­nomic re­al­ity," Cap­i­tal Eco­nom­ics, a con­sult­ing firm, told clients. Econ­o­mists at No­mura, in a Jan­uary re­port, rated the chances of a U.S. re­ces­sion this year at 21 per­cent. The In­ter­na­tional Mon­e­tary Fund has the U. S. and global economies avoid­ing a down­turn in 2016.

Robert J. Sa­muel­son writes a weekly col­umn on eco­nom­ics. View Ar­chive "Con­sumer fun­da­men­tals re­main strong," No­mura says of the United States. "Sig­nif­i­cant pent-up de­mand for hous­ing is likely to sus­tain above-trend growth in res­i­den­tial con­struc­tion. .?.?. The bank­ing sys­tem is well cap­i­tal­ized." (This last ob­ser­va­tion refers to large losses suf­fered by banks in the Great Re­ces­sion that caused many of them to cut lend­ing.)

Sim­i­larly, China's out­look is hardly a re­ces­sion. The IMF fore- casts the coun­try's growth in 2016 at 6.3 per­cent, which - though much less than re­cent rates of 10 per­cent - still ex­ceeds most other coun­tries'. "China's econ­omy is set to slow, but not col­lapse," writes econ­o­mist Paul Sheard of Stan­dard & Poor's.

But there is a less re­as­sur­ing in­ter­pre­ta­tion: The global stock sell- off may re­flect gloomy prospects for "emerg­ing-mar­ket" economies. Th­ese are middle-in­come coun­tries: China, Brazil, Rus­sia, Mex­ico, In­done­sia, In­dia and the like. To­gether, they rep­re­sent nearly half the world econ­omy and, un­til re­cently, were ex­pected to power global growth. Now, many (not just China) are strug­gling with stub­born prob­lems. With hind­sight, their pre­vi­ous rapid growth de­pended heav­ily on a fleet­ing com­modi­ties boom and un­sus­tain­able bor­row­ing.

If this the­ory is cor­rect, then the world­wide sell-off of stocks repre- sents a log­i­cal re­sponse to re­duced eco­nomic prospects. (In the­ory at least, stock prices re­flect to­day's value of fu­ture prof­its.) Un­for­tu­nately, two bits of ev­i­dence sup­port this the­ory. One is oil. Since mid-2014, its price has dived from more than $100 a bar­rel to about $30. Tra­di­tion­ally, lower prices have been seen as a boon. Con­sumers' sav­ings at the pump can bol­ster other spend­ing. But this time, lower prices are also blamed for spread­ing dis­tress and drag­ging stock mar­kets down. Why is this?

Part of the ex­pla­na­tion is that prices are so low that dozens of new ex­plo­ration and de­vel­op­ment projects were ren­dered un­eco­nomic. Oil com­pa­nies have can­celed $1.6 tril­lion worth of projects through 2019, es­ti­mates the con­sult­ing com­pany IHS. The loss of th­ese projects (and jobs) rep­re­sents a drag on the global econ­omy and, to some ex­tent, jus­ti­fies lower stock prices. But that may not be the end of the story.

"Oil is a symp­tom," says Roger Di­wan of IHS. It's a symp­tom of dis­ap­point­ing emerg­ing-mar­ket economies. Low oil prices don't just re­flect over­sup­ply. They also re­sult from soft de­mand. Be­cause in­creased de­mand comes heav­ily from emerg­ing-mar­ket na­tions, they may be weaker than as­sumed. Oil may be the ca­nary in the mine.

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