Investors are continuing to dump stocks as analysts begin to worry about what lies ahead for the world economy.
The latest decline in global stocks followed the arrest of a Chinese technology executive in Vancouver for extradition to the United States. Evidence of a further deterioration in the relationship between the United States and China made for an extremely volatile day in the markets. So did continuing anxieties about slowing economic growth, rising interest rates and the possibility of yet more Brexit chaos.
The selling pressure was much worse earlier in the day in Europe, where many major indexes plunged by more than 3 per cent. Asian stocks were also hit hard.
What is not so clear is whether any of the current concerns are enough to justify what has been a brutal week for stock markets across the world.
Most serious market downturns in recent decades have been caused by either irrational expectations or ham-fisted central banks. The past couple of major sell-offs, in 2001 and ’08, followed notorious outbreaks of investor confidence, in which prices for some major categories of assets reached unprecedented valuations.
The current scene lacks any obvious parallel. In contrast to the dot-com insanity of the 1990s or the U.S. real estate frenzy of 2006, most major investments are trading today at reasonable valuations. Canadian shares, for instance, are changing hands for under 15 times their forecast earnings – the cheapest they have been in five years.
Many other markets also look like bargains. “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,” Mark Haefele of investment bank UBS wrote in a note on Thursday. He continues to be optimistic about the outlook for global stocks.
Central banks don’t offer any glaring reasons for worry, either. In the early 1980s and 90s, the U.S. Federal Reserve precipitated market downturns by rapidly hiking interest rates to painful heights. But the Fed’s raises this time have been gradual and measured, with rates still low by precrisis standards. Many observers now expect the world’s most powerful central bank to ease off its tightening policy by the middle of next year, and Capital Economics says policy-makers will be back to cutting rates by 2020.
Rather than inflated valuations or excessive rate hikes, investors appear to be focused on two scenarios – a significant fall-off in economic growth or a destabilizing trade war. Both fears seem premature.
To be sure, U.S. growth is likely to dwindle as the stimulus delivered by major tax cuts in 2017 begins to fade and trade frictions take their toll. Two-thirds of U.S. economists surveyed by the U.S. National Association for Business Economics in October expect a recession to begin by the end of 2020.
It’s not obvious, though, why a recession expected to arrive at some point over the next two years should send stocks plunging this week. Current data provide little reason to fret. U.S. unemployment continues to hover around its lowest point in a half-century. The latest reading from the Institute for Supply Management shows U.S. manufacturing activity picked up in November, topping expectations.
China offers more reason for immediate concern. The country’s official Purchasing Managers’ Index (PMI), which measures activity in the manufacturing sector, fell in November, missing expectations. The CSI 300 Index, which tracks major stocks traded on the Shanghai and Shenzhen exchanges, has plunged 20.6 per cent since the start of the year, in Canadian dollar terms.
However, there are reasons to think a Chinese slowdown would not be severe as many people think. The country’s official non-manufacturing PMI remains solidly in expansion territory. Capital Economics, which has developed its own gauge of Chinese economic activity, sees Chinese growth slowing only modestly to 4.5 per cent in 2019, down from 5.3 per cent this year, assuming a U.S.-China trade deal can be struck.
Handicapping the odds of such a deal is impossible for now. The arrest on Saturday of Meng Wanzhou, the chief financial officer of Chinese telecom giant Huawei Technologies, suggests tensions are ratcheting higher. However, the 90-day cease fire in the trade skirmish negotiated by U.S. President Donald Trump and Chinese President Xi Jinping, also on Saturday, indicates both sides are open to compromise.
The U.S.-Chinese stare-down has drawn attention away from another market threat: the growing possibility of yet more Brexit turmoil. North American stocks began their first plunge this week on Tuesday, around noon, just as British Prime Minister Theresa May was closing a bad day in Parliament for her proposed divorce deal from the European Union. The timing could be coincidental, but it hints that some investors are watching London as closely as they are Beijing or Washington.
The sheer profusion of possible threats may be weighing on investor sentiment. From slowing growth and rising rates to U.S.-China trade spats and the potential for a disruptive Brexit, uncertainties abound. But reasonable valuations and the still sturdy U.S. economy suggest that investors could suddenly become far more positive if there is even a bit of light on the political front.