Some commentators have rushed to describe the recent global stock market turmoil as “historic” and “unprecedented,” yet its evolution has been quite traditional so far.
What may be different this time, however, is whether longer-term stability can be restored with the policy tools that were available in the past.
This sell-off started as a repricing of global growth prospects. Mounting evidence of economic weakness in the emerging world, along with persistent low growth in Europe and Japan, made it hard for markets to ignore the impact on earnings and profitability of a global slowdown.
The sell-off accelerated as fears spread that policy-makers may not be able to respond sufficiently quickly and effectively. Part of this worry had to do with the extent to which central banks have depleted their ammunition stores after years of carrying the bulk of the policy burden. But a more significant concern arose from the correct realization that the primary response would have to come from the emerging economies that are the source of the growth and financial concerns this time, and not from the Federal Reserve and the European Central Bank.
As is often the case, the sell-off further gathered steam when traders realized that policy circuit breakers would not materialize immediately. The rout became disorderly for a short while when classic deleveraging technical forces, including forced generalized selling by volatility-sensitive investors and overextended portfolios, took hold of the markets. The result was the conventional mix of price air pockets, valuation overshoots and contagion.
Those are the typical stages of a generalized market sell-off. This cycle exhausts itself once prices come down sufficiently to create compelling bargains for sidelined investible funds. This tends to happen first for the best managed companies with resilient balance sheets, and then it spreads to the market as a whole. And there is a lot of dry powder out there, including cash in the hands of households and companies that can be deployed in investment purchases and stock buybacks, or funds parked in bonds whose yields have fallen and that will look for higher-return opportunities.
Longer-term asset price stabilization could also come from a reinforcement of the markets’ economic and policy underpinning. But with economic growth consistently failing to take off, this responsibility has fallen in the recent past mainly to central banks, led by the Fed and the ECB – the system’s traditional core. This time, however, genuine and durable stabilization will require that a good part of the solution come from the emerging world.
Given the economic and political challenges in many of the systemically important emerging economies, it will take time for growth to come back strongly and for comprehensive policy solutions to emerge. These could include the deepening of structural reforms, the rebalancing of aggregate demand or the lifting of pockets of overleverage and overindebtedness.
As a result, the best that can be hoped for right now is short-term market stabilization through another series of liquidity-driven Band-Aids. This approach would provide much-appreciated immediate relief; but it wouldn’t be sufficient to deliver the longer-term anchor of stability that the global financial system is searching for.
Mohamed El-Erian is the chief economic adviser at Allianz SE. He’s chairman of Barack Obama's Global Development Council, the author of best-seller "When Markets Collide," and the former chief executive officer and co-chief investment officer of Pimco.Report Typo/Error