Global markets have been in turmoil in recent days, with the prices of company shares and foreign exchange rates fluctuating wildly. Betty Wong, who covered Wall Street markets for years, takes a look at the herd mentality that can jolt markets around the world.
By Betty Wong
In the analog days, before 24-hour news channels and tweets, a New York Stock Exchange floor trader would learn what was happening by walking to where the selling was coming from. In search of news, a veteran Wall Streeter who was a floor trader in the 1950s and 1960s said he walked around with “a No. 2 pencil and paper.”
The digital age has ushered in an era of real-time news, instant analyses and armchair pundits. It has also altered the dynamics of market contagion and can exacerbate herd mentality.
A paper published in the Journal of Economic Perspectives in 2003, “The Unholy Trinity of Financial Contagion,” analyzed financial crises from recent decades.
Why did some financial crises — the 1982 Mexico bank debt default, 1994 Mexico peso devaluation, 1997 Thai baht float and 1998 Russia bond default — have immediate international repercussions, while others — the Brazil 1999 real devaluation or 2001 Argentina debt default — had muted global impacts?
The authors cited three factors:
- The Capital Flow Cycle – “Fast and furious contagion episodes are typically preceded by a surge in capital inflows.”
- Surprise vs. Anticipated Catastrophes – “Fast and furious crises and contagion cases have a high degree of surprise associated with them while their quieter counterparts are more broadly anticipated.”
- Common Creditors – “International banks played an important role in the transmission of some of the crises of the 1980s and 1990s” as U.S. banks lent heavily to Latin America in the 1980s and European and Japanese banks lent to Asia in the 1990s.
Fear and capitulation are classic signs that the market is bottoming
How does the recent China market turmoil stack up?
- Surge in capital flows? Check. China’s bubble stemmed from investments by its citizens as they moved savings into housing and stocks. As Chinese stocks surged some 150 percent from July 2014 to July 2015, ordinary Chinese citizens jumped into the market, some borrowing money on margin.
- Surprise or anticipated? Both. It’s hard to call the end of a bull market, in the United States or in China. Analysts had warned for months of bubbles in China’s housing and mainland China stock markets. Beijing surprised markets with a yuan devaluation on August 11 and again on August 25 with a cut in interest rates.
- Common creditors: Check. International bank lending to China enterprises has slowed, according to the Bank of International Settlements. Two major British banks have been big lenders to China.
What is interesting is that the China stocks and property bubble has been reported for months, with lots of analysis of its restriction of foreign capital in mainland exchanges. So there should be limited international investor exposure and spillover to global markets.
There were also plenty of cautionary comments about the limited impact of China’s slowing economy, how its growth was still substantial and more robust than in Western economies.
Perhaps widespread rational talk stalled the herd in the pen.
As to where the herd is headed, the Chicago Board Options Exchange Volatility Index, measuring hedging costs on the S&P 500 index, climbed above 53 on Monday, the highest since 2009, before edging lower the next day.
On CNBC on Monday, one long-time trader said he saw signs of “capitulation.” While volatility is likely to continue, fear and capitulation are classic signs that the market is bottoming.
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.