Butterflies and Bubbles: A Review and Forecast of Global Markets

Ever since the last financial crash in 2008, we have successfully avoided another big financial tumble, and have had a relatively strong bull market since then. However, in the words of London based State Street Executive Vice President Michael J Wilson, it has been a very unloved bull market, as everyone is weary of being a believer. Nevertheless, as of late, consumer confidence has been unwavering and global economic growth remained unprecedented, until perhaps now.

Image courtesy of Aldas Kirvaitis © 2007, some rights reserved.
Image courtesy of Aldas Kirvaitis © 2007, some rights reserved.

This past summer, the global markets went through a wild ride that does not appear to be ending any time soon. In the beginning of June, the U.S.’ main stock index, the Dow Jones Industrial average, was able to maintain its heights. However, by the end of August, the Dow had dropped more than 2,000 points from its all time highs, and on August 24 alone, the Dow had dropped 5%. Similarly, China’s main index, the Shanghai Stock Exchange, experienced parallels. After a steep climb starting from the summer of 2014, the SSE peaked at around 5,166 points in May of 2015 and then proceeded to drop to just under 3,000 points by the end of August 2015. With the political and economical instability that transpired during the summer months, it is no surprise that we are looking at the falling markets of the two biggest economic superpowers in the world.

In the midst of 2015, the world was faced with the fear and consequences of the Greek debt and deficit crisis. When the Greek government decided to shut the nation’s banks for a week, the Monday of June 29 saw sharp drops across global markets, especially those in Europe. The UK’s Financial Times Stock Exchange index fell approximately 2%, while other European markets saw drops up to 4%. Following the ensuing German-led talks about the Greek bailout, every time a bailout agreement was met or postponed, global indices, and the Dow in particular, would rise and fall accordingly. If it was not already clear how fragile and susceptible the financial markets are to both domestic and international affairs, the Greek debacle has made it unmistakeable.

China’s butterfly effect is also continuing to batter the markets. Despite low interest rates to boost investment and with fears that Chinese growth might dip below 7% by the end of the year, Chinese investment has tanked. While China’s booming growth may be undeniably slowing down, investors and consumers alike must step back and ask if it may be a blessing in disguise. Stepping back from robust economical growth may allow China to focus on other problems such as domestic security and the consequences of industrial pollution on its populace and environment. However, as a knock-off effect from China, the rest of developing Asia is also slowing down, adding more grief to the global economy. However, it is not just the economies of individual countries that are causing turmoil in the global markets.

Certain commodities can have quite an effect on global equity markets. Since April 2015, crude oil prices have been going down the drain due to an overabundance on the market. While low oil prices bode well for consumers, they have a complex effect on the market. As numerous large oil companies make up indexes such as the Dow and the S&P 500, the low price of oil has driven down the value and profitability of these companies resulting in a negative effect on the stock indices. While part of this supply imbalance is due to the overzealous actions taken by economically oil dependent Gulf countries, the other side to the problem is hydraulic fracturing, better known as fracking, which, until recently, has been in full swing in the U.S. Fracking is a method whereby high-pressure steam or water is used to crack underground rock formations in order to allow oil to flow more freely and be pumped out of the ground. Not only is fracking very expensive, but it also could potentially contaminate underground water supplies and cause earthquakes. For this reason, fracking in places such as New York and Pennsylvania has already curtailed. As fracking becomes less economical when crude oil prices drop, the supply of oil should also begin to wane. As oil is a relatively seasonal commodity, especially as the northern countries start gearing up for a cold winter, demand for oil will temporarily rise, resulting in higher prices. On the other hand, if the price of oil is too high, the fracking or high cost producers would come back into the market, thus stabilizing or lowering prices. Looking forward, since it is a finite commodity, oil prices will eventually rebound; it is simply a matter of when. On the other hand, the lifted sanctions on Iran and potential stability in Iraq pose a threat to the supply imbalance, as both countries have the potential to pump out large quantities of oil. Despite recent chaos in the market due to disruptive economies and capricious commodities, the economies in countries such as the UK and the U.S. are doing well enough to warrant consideration of a rate rise.

That said, due to an unsteady global market, both governments seem to be holding off any decisions concerning interest rates. In fact, the Federal Reserve Bank has been stringing along the decision to raise rates for about year now, thus keeping investors on their toes. This past month, despite the hype that the Fed would finally be raising the rates, the rate change still did not happen. When the news came out, markets dropped further in fear of a faltering economy. Currently, the Bank of England is dealing with a similar situation. Despite signs of a strong, burgeoning economy, the Bank of England is still hesitant to raise rates. While this reluctance may cause unnecessary distress over the global economy, a rate increase may lower investor sentiment even more. While it is uncertain how a change in interest rate may yet affect the markets, what is clear is that some of the world’s strongest economies are suddenly in doubt of their own domestic growth, a sentiment that is reflective of the more than slight drop in the markets.

Looking ahead, in continuation of a fickle summer market, the rest of autumn looks to be just as unstable. With shares continuing to look overvalued, the year looks in for a bear-ish turn. For the time being, with many European and Middle Eastern countries using their resources to alleviate the refugee crisis, we may even see a turn from a focus on international trade to a focus on domestic security and wellbeing. However, with strong economies and consumer confidence still present, there is still hope that we may come out of this market madness alive and well.

 

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