25 April 2019
Stock markets have gone into panic mode around the world. Photo: Reuters
Stock markets have gone into panic mode around the world. Photo: Reuters

Why the worst is yet to come in stock markets

Capital is desperately leaving the market, and a market meltdown without any specific reason is usually the prelude to upcoming “bad news”.

The stock futures for A shares touched the daily down-limit during intraday trading Monday, and the Dow Jones futures also slumped a further 500 points.

Given that the market capitalization of the New York Stock Exchange is more than US$20.7 trillion and that of Nasdaq if US$7.1 trillion, a 1-2 percent drop already means a huge loss.

Two straight days of 3 percent slumps is definitely a market crash.

Meanwhile, capital outflows from emerging equity and foreign exchange markets have been going on for a while.

Over the last 13 months, investors have pulled as much as US$1 trillion from emerging markets, twice the amount in the 2008 financial crisis.

That was merely a reversal of the massive inflow of hot money into these markets as the US engaged in quantitative easing after the crisis.

Currency declines in Asia have been quite stunning.

The Chinese central bank weakened the renminbi by 1.9 percent on Aug. 11, which triggered sharp currency devaluations in Malaysia and Indonesia. Even the Australian dollar has suffered from the sell-off.

The Indonesian central bank used US$300 million to safeguard its currency when the US dollar reached 14,000 against the rupiah, foreign exchange traders said.

The central bank in Vietnam also depreciated its currency. 

Kazakhstan abandoned the trading band for its tenge and adopted a free-floating foreign exchange regime.

The tenge has plunged 30 percent, reflecting the far-reaching implications of the devaluation of the renminbi.

The strength of a currency reflects a country’s foreign exchange reserves, economic growth and production costs.

It’s difficult for a country with fiscal and foreign trade deficits to protect its currency, and the central bank needs to use more capital to maintain the exchange rate if other currencies have weakened.

Global hedge funds have taken the opportunity to attack equity and currency markets in emerging markets.

Investors worldwide rushed to the exits amid a panic sell-off.

Various governments have tried to stem the market slide.

In Chjna, the State Council unveiled a long-awaited plan that allows state pension funds to invest in the stock market.

The 2 trillion yuan (US$310 billion) in pension funds will be allowed to invest up to 600 billion yuan in the stock market.

However, the short-term impact will be limited, given that the pension funds will only start to invest in the market in the second half of the year.

Taiwan’s Financial Supervisory Commission has unveiled three measures, including a ban on short selling, to restore market order.

Where is the money heading?

First, to US Treasury securities.

The 10-year US treasury yield slumped below 2 percent on Monday, the lowest in recent months.

Second, to the euro.

The currency rallied to US$1.15 within four trading sessions from US$1.10.

US treasuries are a short-term safe haven for investors, and capital may not return to emerging markets any time soon, which would exert pressure on equity, currency and bond markets in emerging markets.

Investors should not rush to bottom-hunt in Hong Kong.

This article appeared in the Hong Kong Economic Journal on Aug. 25.

Translation by Julie Zhu

[Chinese version中文版]

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columnist of the Hong Kong Economic Journal

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