25 October 2016
Can't figure out which way the market is going? It might be a sign of trouble ahead. Photo: Xinhua
Can't figure out which way the market is going? It might be a sign of trouble ahead. Photo: Xinhua

Is this another financial crisis in the making?

Abnormal price movement is always a prelude to financial turmoil. The market has performed abnormally recently.

Global equity markets have been disappointing, according to the Global Market Breadth (GMB) index which covers 48 equity indices worldwide.

As of Jan. 12, only 4.2 percent of those benchmarks were above the 50-day and 200-day average.

That means only two markets are still above those levels. The ratio dropped below 10 percent twice last month.

Global equity markets are extremely fragile at present.

And since global equities mirror financial conditions and the state of the world economy, these developments are quite disconcerting.

A temporary correction in the GMB index is not that worrying since it usually results from a single issue.

However, GMB has been constantly below 10 percent, which might signal more financial trouble similar to the crash in 2001 and the financial crisis in 2008.

Market volatility has increased substantially.

Various asset classes saw wild fluctuations last year, with the trend extending into this year.

The CBOE oil volatility index has surged to its highest level since 2009 and VIX index has been climbing steadily, along with the emerging market currency volatility index.

History teaches us that every time market volatility increases, a certain crisis is under way in the financial market such as the 2008 global rout and the 2011 European debt crisis.

The Hong Kong market is witnessing more and more “90 percent down” days again.

That shows the market is also very fragile.

It has already gone through three 90 percent down days when more than 90 percent of nearly 1,800 stocks fell, just two weeks into the new year.

It’s actually quite rare in the Hong Kong market.

We have had less than 100 of those 90 percent down days in nearly 5,200 trading days since 1995.

We have encountered such events in less than 2 percent of our trading history.

The chance of that scenario happening more than three times in 20 trading days is about 0.6 percent.

What does that mean?

We have seen that the 90 percent down days usually appear in the middle of a bull cycle or the middle or end of a bear market.

In this case, it could be a sign that the market correction is about to end, as we witnessed in 2004 and 2006.

However, it could also mean the market may fall further if we are just in the middle of a bust cycle.

The Hang Seng Index has lost about 9,000 points since mid-2015, reflecting a bear cycle.

Repeated 90 percent down days also happen when the market is heading toward a financial crisis, such as the 1997 Asian turmoil, the 2008 global crisis and 2011 debt crunch.

In this case, another crisis might soon emerge as suggested by various technical benchmarks.

The good news is that as the GMB index drops to record lows, the market is oversold, if not in a panic sell-off.

A rebound could take place anytime soon.

The bad news is that headwinds remain. Any uptick is likely to be short-lived.

Investors should gear up for further market volatility going forward and sell in the event of a rally.

This article appeared in the Hong Kong Economic Journal on Jan. 14.

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist

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