The third quarter of 2015 – or maybe, from a European perspective, the second quarter – will be remembered as the date when the global equity bull market ended that had started in the first quarter of 2009. Over the course of six years the S&P 500 more than tripled, the Nikkei (although joining the party late) almost tripled, and the Euro Stoxx 600 gained 160% (all in local currency). Both in length and in strength, the rebound in international stock prices after the market crash in 2007-08 was remarkable.
The only group that probably felt a bit of a wallflower at the party were investors in emerging markets (EM) equities. In the early phase of the bull market EM indices rallied and outperformed their developed market peers, but since 2011 EM equities mostly moved sideways. The MSCI EM index – despite more than doubling between 2009 and 2015 – never managed to see its pre-crisis top again.
While the end of the bull market is a certainty now, the more relevant question is whether going forward the current meltdown will stop and turn into a ‘normal’ correction that will soon be over, or whether we should fear a replay of 2007-08 when global equity markets lost 60% or more of their value.
So far, since their peak last year, many financial indicators are closely tracking their performance in 2007-08, including the world’s key equity indices. The Euro Stoxx 600, for example, had lost 27% since April 2015 as of February 11, which is even a bigger loss (23%) than the index showed in 2007-08 in the same period following its peak (Figure 1).
In the US the picture is slightly different. After a sharp correction in August 2015, the equity market posted a strong rebound in the autumn, driven by a decent earnings season and, more importantly, by hopes that the US Federal Reserve would not hike interest rates. However, in the first few weeks of this year US equities also tanked. In the meantime – seven months after its peak – the S&P 500 has shed 15%, significantly more than what it lost (10%) in 2007-08 over the same period (Figure 2).
Emerging markets are no exception. EM equities lost 24 % from their peak in April 2015, slightly less than in 2007-2008 (Figure 3). This is an important reminder that in a globalized world it does not matter where the mayhem starts. In 2007, the crisis had its origins in the US and spread to Europe and emerging markets, while now the latter two are also among trouble spots. Still, in terms of how deep the suffering turns out to be, it does not seem to matter where the woes begin.
That said, there is always the possibility of making bad things worse on a regional level. In Central Europe, stock prices shed on average a third of their value in less than ten months after their peak, while during the last crisis they had lost only 20% over the same period (Figure 4). The only explanation for the region’s current massive underperformance has been the political change in Poland, where the new government saw it as its first priority to sour the country’s relationship with the EU.
The million-dollar question (shouldn’t this idiom be finally inflated when applied to financial markets?) presently is: where do we go from here?
In a way, the situation is now more complex than in 2007-08. Back then, the crisis was triggered by the bursting of a financial bubble – bigger than ever before, but otherwise fully in line with the mechanics of how bubbles burst (ie. inflated asset values returning to their true value, which often enough was nil). This time, however, the sources of the financial markets’ turbulence are much harder to pin down. Is it the growth slowdown in China or the drop in crude oil prices? Is it Fed tightening and the fears of a recession in the US, or are investors scared by the centrifugal forces in Europe – first in Greece, now in the UK? Or is it the reversal of capital flows from the emerging back to the developing world, which will likely create problems for a number of ‘fragile’ emerging economies like Turkey or South Africa? And as if this would not be enough to spoil the average fund manager’s day, in recent days concerns about the impact of negative interest rates on the health of the banking sector were added to the list.
In fact, all these factors are serious, but none of them, in itself, looks dangerous enough to fully explain the recent market rout. Instead, there may be two other factors at play.
One is herding. Olivier Blanchard, the International Monetary Fund’s previous chief economist, has recently pointed out that, for example, neither the impact of China’s growth outlook nor the drop in oil prices is as worrisome as financial markets assume. He believes, “that to a large extent, herding is at play. If other investors sell, it must be because they know something you do not know. Thus, you should sell, and you do, and so down go stock prices”.
Another factor that is likely fuelling investors’ fears is the feeling that economic policy is running out of instruments to fight another crisis, whatever its sources. Monetary policy is still in crisis mode, relying either on ultra-low/negative interest rates or on bloated central bank balance sheets, or on both. And fiscal policy, which could have an impact, is partly discredited and partly hindered by high public debt levels, particularly in the developed world.
Bottom line: The charts presented above should be taken with a grain of salt, because charts don’t predict the future (something everybody knows except technical analysts). However, the fact that global equity markets so far have been closely tracking their downward path during the previous crisis is clear evidence that we are in a middle of a serious market correction.
Of course, following the bloodbath in recent days, we could see a rebound in the near term when investors realize that the world economy is growing and fundamentals in Europe and emerging markets are not as scary as thought. But given the broad range of issues that the world economy is facing at present (and we did not even mention the geo-political tensions in various parts of the world), any hopes of a return of a solid bull markets look starry-eyed.
Peter Szopo is chief equity strategist at Erste Asset Management. Any views expressed are his own.