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Has the US share market – which only was celebrating its achievement in hitting an all-time high – become the latest shoe to drop as the scourge of tightening financial conditions and escalating trade tensions between the world’s two largest economies works its way through global markets?
Investors are fearful the latest vicious sell-off in the US share market – which saw US stocks suffer their heftiest losses in more than eight months – could be a foreboding of even heavier losses to come.
They’re fearful the risk-aversion that first showed up in the cryptocurrencies, before spreading to the emerging markets may have now infected the $US40 trillion ($57 trillion) US equity market.
It’s hard to credit that this time last year, the speculative mania surrounding bitcoin was in full swing, helping to propel price of the virtual currency close to $US20,000 at its December peak. Since then, a sense of doom has hovered over the digital currencies, sending the bitcoin price hurtling back to around $US6,200.
Emerging markets were the next to feel the pain from the pullback of speculative hot money, as investors worried the combination of rising US interest rates and a stronger greenback would push their borrowing costs sharply higher. The MSCI Emerging Market stock index has now tumbled 24 per cent from its January peak.
Pain just starting
Until recently, US share market investors largely shrugged off the brutal price corrections in digital currency and emerging markets. After all, they reasoned, as financial conditions tighten, it’s always the fringe asset classes that suffer the worst pain because nervous investors inevitably dump their riskiest assets first.
But the latest sell-off in US shares, coming hard on the heels of a rout in the US bond market which have seen the yield on benchmark US bonds climb to their highest level in seven years – has sparked fears the troubles are no longer confined to the periphery, but have infected the core.
Underlying this spreading unease, there’s a growing disquiet the spectacular explosion in asset prices since the financial crisis is solely due to the ultra-easy monetary policies adopted by the world’s major central banks, and particularly the US Federal Reserve.
And despite the protestations of US President Donald Trump – who says US central bank has “gone crazy” with its rate hikes – investors now believe the Fed, faced with overwhelming evidence of strong economic conditions, will continue to push short-term US interest rates higher.
At the same time, the pressure on longer-term US bond yields shows no sign of abating.
Investors are nervous about the avalanche of US government debt that is about to hit the US bond market, as the US budget deficit swells to $US1 trillion in fiscal 2019.
They’re also battening the hatches for a protracted, full-scale trade war with China, with the Trump administration likely to have imposed a 25 per cent tariff on all Chinese-made goods by early next year. Higher tariffs will only add to the price pressures building up in the US economy.
Dual sell-off a major concern
Analysts note what’s particularly worrying about the latest US sell-off is that both bond and equity markets are both being pummelled at the same time.
Normally, investors respond to a sharp sell-off in US stocks by taking refuge in safe haven bonds, and their buying pushes bond yields lower. (Yields fall as bond prices rise.)
But the action in markets on Wednesday night demonstrated that investors are no longer convinced that bonds are such a safe haven. Even though the US share market lost more than 3 per cent, and the tech-heavy Nasdaq plunged more than 4 per cent, the yield on 10-year bonds finished pretty much unchanged.
Now, this is a deeply worrying development for all investors, and not only for the myriad of “risk parity” funds – which control an estimated $US500 billion in assets – whose investment approach is based on the basic premise that bonds and equities have a negative correlation, ie that when the price of one goes down, the other goes up, which dampens volatility.
The niggling worry for investors is that there may no longer be any financial asset – apart from cash – where they are guaranteed immunity from capital loss.