Stock markets around the world have fallen sharply. The question is: How vicious can the bear become?

Sculpture of a bear,, Frankfurt, Germany, 12 September 2011. (EPA/Frank Rumpenhorst)
Sculpture of a bear outside the Frankfurt Stock Exchange (EPA/Frank Rumpenhorst)

by Betty Wong

The nation’s heartland boomed to meet the global economy’s insatiable demand for its exports. Middle-class citizens began investing in stocks and buying on margin, helping to fuel the stock market’s dizzying climb. Individual investors pulled savings from banks and invested in stocks for what seemed to be a sure bet.

Then industrial demand slowed and firms struggled to sell products. The stock market tumbled and rebounded a few months later. Following a spate of bad financial news, investors panicked.

What followed was the U.S. stock market crash of 1929. The great bull market had turned into a bear.

While parallels could be drawn between the United States of the roaring 1920s and present day China, a Great Depression is not likely in the offing. However, global stocks seem to have started pricing in a global recession.

MSCI's global ACWI index is in bear territory (Reuters)
MSCI’s global ACWI index is in bear territory (Reuters)

The bulk of major stock markets around the world officially entered bear territory by falling 20 percent or more from their highs.

The question is: How vicious can the bear become?

As of last week, stocks in bear territory included indices in Britain, China, Canada, France, Germany and Japan. Global stocks have lost nearly $8 trillion in market value since the start of 2016, weighed by fears of an economic slowdown in China, the world’s second-largest economy, and cheap oil.

While global stocks largely shrugged off China’s stocks stumble last summer, investors are increasingly concerned now about Beijing’s ability to manage China’s once-booming economy.

Things to consider for the outlook on global stocks:

  • Small-cap stocks are in bear territory, but keep an eye out for how much lower the S&P 500 and the Dow Jones Industrial Index fall. The latter two have undergone corrections of falling 10 percent or more from highs. The United States is the world’s largest economy and remains an engine for global growth, even if U.S. growth has not been robust.
  • Beware of false rallies. There are rallies in bear markets, too, and bearish professionals generally advise to sell into rallies on the belief stock prices will head lower. While last Thursday and Friday’s Wall Street rally was welcome, professionals are still looking for “capitulation,” a crescendo of panicky selling that marks a market bottom and signals skittish investors have been washed out.
  • China has one of the world’s most volatile stock markets. Its stock market is young, faces intense government intervention and is heavily invested by retail investors rather than institutions. Xiao Gang, head of the China Securities Regulatory Commission, recently said the Chinese market’s volatility “shows an incomplete trading system, an imperfect market system and an unadapted regulatory system.”

As to whether global stocks can decouple from China’s downward spiral, some experts note markets don’t always trade in lockstep and China has never yet pushed Wall Street into a bear market.

According to Fundstrat Global Advisors, over the past 25 years the Shanghai composite index experienced 10 bear markets lasting a total 188 months, or 60 percent of the time. By comparison, Fundstrat said, the S&P 500 only had two bear markets over the same period for a total of 52 months, or 18 percent of the time.

Shanghai index (blue) versus S&P500 (red) over the past 10 years (Yahoo! Finance)
Shanghai index (blue) versus S&P 500 (red) over the past 10 years (Yahoo! Finance)

 

bwong

Betty Wong was global managing editor of Reuters from 2008-11, with 29 years of experience at the Wall Street Journal and Reuters. She covered white collar crime on Wall Street from Ivan Boesky to Michael Milken in the 1980s, led U.S. corporate news coverage from the dot com bubble to rubble and was global equities editor for Reuters overseeing 500 reporters covering company and stock market news. Her favorite beat was covering the U.S. stock market as a reporter and the unique personalities on brokerage floors.

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