Why are Global Stock Markets Falling?

Asian stock markets fell dramatically on Tuesday in reaction to US equity weakness on Monday; is this the beginning of the end of the bull run?

Emma Wall 6 February, 2018 | 6:44AM

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It is said that when the US sneezes, the rest of the world catches a cold; and that has certainly proved to be true this week as a fall in the US stock market triggered a global equity downturn.

US stocks listed on the Dow Jones, S&P 500 and tech-focused Nasdaq markets have fallen 8% since their all-time highs last month, in reaction to stronger employment figures released on Friday. The market is concerned that the good jobs figures will provide further evidence of a strong economy to the US Federal Reserve central bank, and force the Federal Open Market Committee to raise interest rates faster and higher than predicted. This in turn would make fixed income assets more attractive, and trigger investors to sell higher-risk equities for the more attractive income of a lower-risk bond. 

Immediately after the jobs figures were released, showing 200,000 more jobs in January, and a rise in wages not seen for eight years, US government bond yields did rise. Interest rates on 10 year Treasury bonds rose to 2.84% on Friday, but this lift was almost immediately reversed on Monday as investors rushed to take advantage of the lower price and higher yield, causing the biggest one-day decline in the US 10 year T-bond yield in five months.

Last month, Gary Kirk, fixed income fund manager at TwentyFour Asset Management, predicted this pattern saying: "The current bond market cycle will continue as is for a while. The market remains expensive for much longer than they remain cheap. When markets become cheap money rushes in and closes the arbitrage.”

Will Stock Markets Rally Again?

But equities are another story - the falls in bond prices may have been easily closed, but stock markets dip on Friday extended into Monday, and Asian stocks have opened significantly down on Tuesday too. 

While emerging markets including China – and especially India – are growing at a far more rapid pace than the US economy, the US remains the largest economy in the world, and so it is unsurprising a stock market blip across the pond will have a global impact. The Nikkei in Japan fell 1,500 points in mid-day trading, equating to nearly 7%, the Hang Seng fell more than 4%, and the Shanghai Composite is down more than 3%.

JP Morgan's chief market strategist for Asia Tai Hui said that it was “healthy and normal for equity markets to experience pullbacks”, and that investors should keep faith in the strong underlying fundamentals.

“We don’t see the current sell-off transcending into a bear market. Bull markets don’t typically die of old age, they are usually killed by central banks aggressively hiking interest rates,” he said. “Although markets are finally slowly starting to fully price in expectations of interest rate increases from the US Federal Reserve, we don’t think central bankers will risk moving too quickly and endangering the recovery they have painstakingly coached for the last decade.”

Hui says that this blip is nothing more than investors taking profits after a strong bull run, adding: “we see little risk of recession and that earnings expectations remain strong, we would view this as a buying opportunity”.

But Hussein Sayed, chief market strategist at foreign exchange specialists FXTM says that era of cheap money is ending, and for markets addicted to quantitative easing, it’s undoubtedly bad news.

“Equity bulls may argue that despite the spike in bond yields, they are still considered much lower than where they stood back in 2007 when 10-year treasury yields peaked at 5.33%. This is entirely true, but also in 2007, the S&P 500 cyclically adjusted PE ratio peaked at 27 compared to 33 currently,” he warned.

“Although the earning season looks magnificent, forward PE ratio stands above 18 times, which is significantly higher than both the five and ten-year averages. The markets' overstretched valuations may no longer be justified when interest rates surprise to the upside.

The only way to justify high valuations going forward, is to see economic and earnings growth resuming their uptrend, despite facing higher borrowing costs. Will President Trump’s fiscal policies make the magic? That is what equity bulls should bet on.”

 

 

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About Author Emma Wall

Emma Wall  is Senior Editor for Morningstar.co.uk