As Europe and North America slept on Sunday night, Chinese markets went through the floor — the Shanghai Composite index of stocks fell by 8.49%, the biggest single-day collapse since 2007.
It wasn’t alone. Hong Kong’s Hang Seng fell 5.17%, Japan’s Nikkei fell 4.61%. Stocks in Taiwan, the Philippines, Singapore and Thailand also tumbled.
US markets joined the collapse, with the Dow falling 1,000 points at the open — though as of 5 p.m. London time (12 p.m. ET) it’s more like 300 points down. Commodity prices crumbled too.
It’s one of those days where prices are moving so fast that it’s difficult to get any idea of momentum during the day, though the overall picture is a major selloff.
But what’s the cause?
The more you look, the more it’s clear that there’s no one single catalyst. Many people are pointing towards China as an explanation, but it’s not clear what spark exactly they’re identifying. In analyst emails and on social media, people seem to be mentioning five things,
1. China might not be able to control a stock market collapse.
The Chinese government has staked its reputation on its capability to keep stocks buoyed up, and that’s now at risk. The announcement over the weekend that pensions funds would be able to invest much more in the stock market seemed to do almost nothing to soften the implosion today.
Some analysts also expected the People’s Bank of China to cut interest rates over the weekend, and that didn’t come about.
But that doesn’t really make total sense, or at least doesn’t explain the crashes outside of China. — Shanghai stocks have tumbled nearly 40% since June and western markets haven’t reacted like this before. We’ve known China’s economy was slowing down for quite a while — so why now?
2. Something to do with China’s devaluation of the yuan last week
Here’s SEB cross-asset strategy chief Thomas Thygesen, via the Guardian: “GDP growth in the U.S. and euro zone economies just isn’t strong enough to prevent a global disinflationary shock from accumulating… People have realised there could be further weakness in the Chinese currency. They don’t seem in control of the situation and we could see feedback loops that haunt the U.S.”
All else being equal, a devaluation in China will cause further disinflation and deflation around the world.
Maybe both the part about China’s currency and the part about US and Eurozone growth are true. But again, it’s hard to see what happened between Friday afternoon and Monday morning that caused such a realisation. Expectations for US and European growth haven’t changed, and there’s no obvious catalyst for a change of heart in terms of the Chinese currency.
4. Expectations of a Federal Reserve rate hike.
The Federal Reserve could hike interest rates in September, something it’s been hinting at for quite some time now. Generally, that would be a little negative for equities. It would be even more negative if, as the European Central Bank did in 2011, rates were hiked and the economy tanked in response.
But September has been in play as a potential month for a rate hike for a very long time now. And again, we knew nothing more on Monday morning about the health of the US economy than we did last week. It is in no way a new development or surprise.
5. Other emerging markets will suffer
The Federal Reserve’s looming interest rate hike is a concern for emerging markets, which tend to suffer when the dollar is strong.
Here’s the view from Capital Economics: “Worries about new crises in emerging markets are exaggerated. True, local currencies have fallen sharply. However, with little risk of inflation taking off and dollar-denominated debts generally much less of a concern than before, weaker currencies may actually help to support growth in EMs.”
6. Animal spirits
Admittedly this one is a bit of a cop-out. But when nothing rational is left, it’s what you’ll often hear analysts blame a market rout on. Here’s the original use, from John Maynard Keynes in 1936:
Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits — a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities
So perhaps the slump was an overreaction. A handful of semi-connected and negative stories about the economy, combined with a bit of herd behaviour. Or perhaps it’s a delayed reaction, and markets are correcting for Chinese weakness that they should have taken into account for weeks and months ago.
Or maybe it’s something else entirely. All that’s clear at the moment is that none of these putative explanations really makes sense.