Global equities sell-off may not be over
THE DOW JONES INDUSTRIAL AVERAGE CLOSED MORE THAN 2% LOWER ON FRIDAY TO CLOSE AT 24,388.95
The sell-off in global equity markets may get worse in the days ahead as the end of the quarter nears. The scepticism about a trade deal between the United States and China and a vote on a Brexit deal may weigh on equity indices going forward, which will coincide with potential profittaking that funds undertake at the end of the year followed by re-positioning.
The Dow Jones Industrial Average (DJIA) closed more than 2 per cent lower on Friday at 24,388.95, bringing the five day fall to more than 4.5 per cent.
The S&P 500 index closed 2.33 per cent 2,633.08 after losing more than 4.6 per cent last week. “My fear is price action could get uglier as we near year-end while compounded by worsening liquidity,” Stephen Innes, Head of Trading APAC at OANDA in Singapore said.
Plus, the arrest of Meng Wanzhou, Chief Financial Officer of Chinese tech firm Huawei may also add to the scepticism of a possible truce in the trade war.
“Investors have grown concerned that a trade truce between the US and China brokered over the weekend could prove short-lived. Such worries have been stoked by a US request for the extradition of Meng Wanzhou, suggesting that talks between the US and China are unlikely to be productive,” Mark Haefele, global chief investment officer at UBS said. The DJIA has given up all the gains registered so far in the year, and the index traded more than a per cent lower as a potential trade war between the US and China is seen slowing global growth. The Asia Dow index closed 0.09 per cent lower at 3,177.37.
UBS continues to retain its overweight position on global equities although it expects higher volatility.
“The sell-off since early October has now left global equities at a roughly 15 per cent discount to their average trailing price earnings ratio over the past three decades. With the global economy continuing to grow and positive earnings, we retain our overweight in global equities. That said, investors need to brace for higher volatility as the cycle matures and as US-China tensions remain elevated,” Haefele said.
Headwinds
But headwinds are many for the equity markets. “We expect some of this technical weakness to continue over the next weeks as the ‘Brexit uncertainty, fragility of the Italian politics and, most importantly, decelerating growth act as headwinds. After a brief relief rally, investors are coming to a realisation that the ceasefire in the China-US trade talks is only temporary and lacking detail,” Karolina Noculak, Investment Strategist, Aberdeen Standard Investments said.
Gold, seen a safe haven, has not been benefiting much from the headwinds.
Prices have been gaining steadily. Comex gold for Feb delivery traded at $1,254 an ounce on Friday, but were still down from the high of $1,400 seen in early 2018. “The uptrend in gold that was established after hitting a low point in August and following the break above the October high may now attract additional short covering from hedge funds who have been holding a net-short position since July,” Ole Hansen, head of commodity strategy with Saxo Bank said.
Whenever stock prices rise or fall sharply, there is a natural instinct to ask what happened in the world to suddenly change perception of longer-term investors and shorter-term traders about the prospects for the economy.
After all, economic theory — the socalled efficient market theory — would have us believe that the previous level of stock prices reflected a valuation by millions of sophisticated investors based on all the available data. So the only thing that can explain the new valuation is some new information, in this case prompting all sorts of theories about oil prices or the slowdown in home sales or increased trade tensions that will lower global economic growth.
Or maybe the movement in stock prices, in fact has very little to do with that. Yes, some of those developments have altered the outlook for the economy and corporate profits. But more likely those are triggering events than the underlying cause of the wild swings in stock prices — matches thrown on a pile of dried wood pile.
The real change is that investors have gone from people (and computers) buying stocks on the expectation that stock prices would continue their steady climb over the last years, to people (and computers) selling stocks because they no longer believe that to be true.
Or put another way, the market is making the transition from people buying stocks because everyone else is buying them to selling stocks because everyone else is selling them. It goes by the name of herd behaviour, or momentum investing, and it is the only thing that can explain why, in the 16th century, people were paying as much for a single tulip bulb as they would pay for four fat oxen, two tonnes of butter or a thousand pounds of cheese.
Did those crazy Dutch really think a tulip bulb was as valuable to them as a thousand pounds of cheese? Of course not. On financial markets, as the great British economist John Maynard Keynes observed, the task of the trader isn’t to calculate the genuine economic value of an asset based on all the information available. Rather, it is more simply to figure out what some other fool will pay for it in the next minute, the next hour, the next day or the next month. Rather than being rationally efficient, financial markets have a predictable tendency to be irrationally inefficient, driven by self-reinforcing cycles of fear and greed in which buying begets more buying and selling begets more selling.
Everyone on Wall Street knew that a bubble had developed in stock, bond and real estate markets, one that was made possible by lots of cheap credit provided by the Fed and other central banks, and that a correction was inevitable. But as with any dynamic that feeds on itself, you never know when that will happen — and if you bail out too early, you can miss a lot of upside. Indeed, the wise trader knows that these movements up and down always last longer than people think possible — so long, in fact, that the early sceptics give up and throw in the towel. It’s only when these sceptics finally capitulate and rejoin the herd that markets turn and head in the other direction.
For if a market peak or bottom were really obvious and predictable, then in a forward-looking market it would have already happened.
I’m sure that as you are reading this, there are bullish analysts on Wall Street assuring clients and the media that investors are being irrational, that the market is now oversold, that prices have swung too far below economic fundamentals.
Long and short of it
But remember that just as the economic fundamentals drive the markets over the long run, markets can drive the economy in the short run. Whether justified or not, falling stock prices caused consumers and businesses to pull back on their spending, which will eventually cause the economy to slow, causing forward-looking stock prices to fall even farther today. In that way, the downward spiral feeds on itself.
Moreover, this vicious cycle is apt to accelerate even more when those who have bought stocks with borrowed money are forced to sell by lenders whose collateral — the stock — is now valued at less than the original loan. In that way too, selling begets more selling.
This is what a bear market looks like: Four steps down, two steps back up, then four more steps down. And just as on the way up, it won’t be over until market sentiment becomes overwhelmingly bearish and the dwindling number of bulls finally throw in the towel. We’re still a long way from that point. And until we get there, you might want to save yourself the time and aggravation of trying to figure out why the Dow Jones average just fell 600 points while you were having lunch. And if we in the business press were being honest, the headline on the story that day would be the same as it was the day before, and the week before that:
“Stocks fall because stocks fall.”