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What’s Causing Global Stock Market Meltdown?

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Steve Pomeranz

As most of you know, it’s been an incredibly volatile week for stocks.

Moments after the U.S. stock market opened on Monday, the Dow Jones industrial average had plunged nearly 1,100 points – a four-digit decline that is enough to jolt even the most blasé of investors.

Then, only minutes later, the market launched a furious comeback as investor sentiment shifted on a dime, and within three hours the market erased most of its losses. But the rally ran out of gas and the Dow ended down 588 points, or 3.6% – its 8th-worst point-drop in history. At the end of the day, the Dow was down 13.3% from its record high of 18,312 set on May 19 – that’s well within what Wall Street calls a correction, a loss of 10% or more from a recent high. And the declines over the last three sessions had wiped out $2.2 trillion of U.S. stock market value.

Then Tuesday saw a lot of volatility. Stocks initially jumped but then faltered… whipsawing the Dow from a 442-point gain to end 205 in the red after a brutal, six-day losing streak.

And We’re Back

But after weighing everything, Wall Street concluded things were not as dire as some may have thought, and buyers poured into the U.S. stock market on Wednesday, sending prices soaring to their best overall one-day gain in nearly four years and snapping a week of punishing declines as investors gobbled up suddenly cheaper shares.

The Dow surged 619 points on Wednesday, nearly 4%, to its best advance on a percentage basis since late November 2011. Stocks also closed sharply higher on Thursday, with the Dow up 2.3%, on unexpectedly brisk U.S. economic growth in the second quarter and a surge in orders for durable goods, such as cars and appliances in July, that suggests our economy remains on firm upward footing and that the manufacturing sector may be digging its way out of the malaise it endured in the first half of the year. The gains followed reports of increases in U.S. consumer confidence and new home sales earlier in the week.

investors were lured back in by sharply lower stock prices, with more people asking, ‘should I buy?’ than ‘should I sell?’

Many investors were also lured back in by sharply lower stock prices, with more people asking, ‘What should I buy?’ rather than ‘What should I sell?’. 

So what caused the global stock market meltdown?

The global plunge in stocks was triggered by China’s move about two weeks ago to devalue its currency. Although Beijing said the action was in line with a policy change to make its exchange rate more market-driven, many analysts took the announcement as an indication that the Chinese economy was slowing more sharply than previously thought.

Then, those fears intensified on economic reports from China showing a worse-than-expected decline in exports and industrial production, and a plunge in China’s stock market, which exacerbated worries about the Chinese government’s inability to manage its financial market and economy.

Now… investors have good reason to be concerned about a sharp slowing in China’s growth… because China is the world’s second-largest economy, behind the United States, and has been a major engine of global growth over the last decade.

China is also the biggest trading partner for most countries in Asia, the fastest-growing region, and it is the world’s biggest consumer of copper and many other commodities, which are important to countries around the globe.

Some analysts also say that the Federal Reserve is partly to blame for the steep decline in stocks since Wednesday of last week… because minutes of the Fed’s last meeting showed that the central bank remains deeply divided over whether to begin raising interest rates in September, as many were expecting and that added to the uncertainty and anxiety in financial markets around the world.

The sharp correction left investors facing at least two key questions:

When the market soared from its opening plunge on Monday, was that a sign of underlying strength and attractive stock values that could mean higher prices ahead?

Or was the rally just a temporary upswing that Wall Street coarsely calls a “dead cat bounce,” one that often involves traders buying stocks simply to cover earlier short sales when they bet prices would fall?

Many analysts took the bullish side and said it showed the market’s resilience… that we are in a volatile market, and these pullbacks are going to occur… but the market is definitely not on a path to a recession and should go higher over the long run after what was seen as a long overdue healthy correction.

What does this mean for the U.S. economy?

At this point, few experts are predicting that market jitters will derail the U.S.’s six-year-long economic expansion. Analysts point out that fewer Americans today own stocks than during the 2008 financial crisis, and corporate America has a lot of cash in hand as many companies reaped a string of record profits during the recovery.

This latest bout of market turmoil has also raised the odds that the Federal Reserve will delay plans to raise its benchmark interest rate next month.

And the pullback has shaken business confidence, and could translate into weaker investment, hiring and spending… and fan fears, crimp global trade and further hamper many other economies, which in turn will hurt U.S. exports and manufacturing.

The good news, though, is that experts are not worried that China’s market problems will trigger a global financial crisis as the Lehman Bros. collapse did in 2008. Beyond that, many analysts believe that China’s economic growth, while slowing, won’t tumble into a hard landing because although China’s manufacturing sector is struggling with excess capacity, its larger service industry is doing better and problems have eased in the country’s overheated real estate sector also.

And there is a silver lining… with investors worried about weaker demand from China and elsewhere, the price of oil has fallen to fresh six-year lows… and this helps our economy – because the U.S. is a net importer of oil, and cheaper fuel means more money in consumers’ pockets to spend on other things, and should help businesses cut their energy costs.

In summary, this correction was long overdue and was no great surprise. I think it did a good job of gently tapping the market’s brakes and reminding investors to weigh global risks and how they might impact profits and stock prices at U.S. corporations in the years ahead. And strong economic data earlier this week helped restore confidence in the fundamental strength of our economic recovery – so, in my opinion, stocks continue to be a good long-term investment for U.S. investors.