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Thursday, January 28, 2021
Impending Systemic Retracement in Global Stock Markets
ANBOUND

While retail investors have been able to fend off some short sellers by driving a surge in some U.S. small-cap stocks recently, their enthusiasm has not reversed the downward trend in the U.S. stock market. On January 27, the Federal Reserve's decision to continue the quantitative easing policy failed to maintain the upward trend of the U.S. stock market. The three major indexes all fell by more than 2%, led by chips, new energy vehicles, and bank stocks, which was the worst performance of the U.S. stock market since October 28 last year. The S&P 500 fell 2.57%, the Nasdaq Composite fell 2.61% and the Dow Jones fell 2.05%. Notably, the VIX, a measure of market volatility, surged 61.6% on the day to a near three-month high of 37.

Figure: Changes in the VIX volatility index

Source: Investing.com

This downward trend also spread to Asia-Pacific markets on January 28, setting off a ripple effect. Hong Kong's Hang Seng Index closed down 2.55% on January 28, led by technology stocks, which plunged 4.43%. South Korea's KOSPI Index fell 1.71%, Japan's Nikkei 225 Index fell more than 1.53%, India's S&P BSE SENSEX Index fell nearly 2%, Singapore's FTSE Straits Times Index fell 1.30% and Vietnam's Ho Chi Minh Stock Index, which has gained last year, fell 6.67%. In China's A-share market, the Shanghai Composite Index fell 1.91% amid the central bank's continued withdrawal of short-term liquidity, guarding the mark of 3500 points. The Shenzhen Component Index fell 3.25% and the ChiNext Index fell 3.63%. Currently, the European stock markets also ushered in a generalized downward trend. The STOXX Europe 600 Index was down 1.54% at 18:00 Beijing time, after falling as much as 1.8%. Germany's DAX 30 Index fell 2.09%, France's CAC-40 Index fell 1.42%, and Britain's FTSE 100 Index fell 1.85%. Judging from the situation of the main markets, this downward adjustment across the board is not an isolated case, rather it is something that has become common. Of course, this short-term pullback is not necessarily continuous, but it has spread globally and its magnitude is too huge to ignore. This kind of sharp pullback with the universality indicates that a systemic retracement in global capital markets is imminent.

As far as the U.S. is concerned, many in the market have attributed the stock market decline to the Fed's stance on the outlook for the U.S. economy. While the Fed said the outlook for the U.S. economy is optimistic and decided to keep interest rates, easing policy as well as its stance on inflation unchanged, its statement also pointed out that the pace of recovery in economic activity and employment has slowed in recent months. This in fact means that the future of the U.S. economic recovery is not quite optimistic. This "misalignment" with market perception will increase the intensity of market adjustment. Some in the market have expressed concern that the U.S. economy could lose momentum in the first quarter of this year, given continuing concerns about the pandemic and a disappointing pace of vaccination. Fed Chairman Jerome Powell also said, "The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved." In particular, the Fed said that novel coronavirus poses a significant risk to the economic outlook, with the weakness in the economy is concentrated in industries most severely affected by the outbreak, and that the path of economic development will largely depend on the course of the outbreak and the progress of vaccines. The Fed sees a moderate pace of economic and employment recovery. The public health crisis continues to weigh on economic activity and poses considerable risks to the economy.

In fact, the Fed has a more realistic outlook for the economy, which reflects the fact that the pandemic is still the biggest uncertainty. However, it was interpreted by the market as an indication that "Fed officials do not know how long the uncertainty will last." With the COVID-19 outbreak once again worsens globally, while vaccine deliveries and production falling short of expectations, there is concern that the impact of the outbreak will continue, affecting the economic recovery and increasing uncertainty in the capital markets.

In fact, many institutional investors are getting concerned about a market bubble as global stock markets continue to inflate. When Powell was asked about his perspective on the markets after the Fed meeting, he responded that the Fed is indeed concerned about asset prices, leverage, and financing risk in the banking and non-banking sectors. He added that monetary policy is not the main driver of asset prices. Powell may not be speaking from his heart. In fact, this is not only true in the United States, but also in China where there is much analysis that capital market bubbles pose risks. On the global scale, both developed markets and emerging markets have experienced high asset price inflation amid the flood of liquidity. In fact, as ANBOUND has previously pointed out, the global asset price inflation is largely the result of a flood of liquidity. This is out of step with economies around the world that have been hit hard by the pandemic. The stock market has become very sensitive because of fears of a bubble.

The market bubble, inflated by the liquidity flood, is beginning to face the problem of sustainability. Without the support of real earnings, growth momentum will inevitably "falter" and face a turning point, even if accommodative policies remain in place. In anticipation of a short-term containment of the pandemic, asset bubbles can still be sustained by liquidity. As the COVID-19 pandemic is likely to continue to spread this year, sustaining growth in capital markets will require further efforts on top of last year's unprecedented monetary easing. However, the monetary policies of central banks around the world are currently facing the problem of sustainability, and the supporting effect of monetary policies is bound to continue to weaken in the future. In this case, global stock markets are bound to face a systemic adjustment. The risk of such an adjustment will bring greater harm than last year's stock market crash, and require investors to be more cautious.

Final analysis conclusion:

As the COVID-19 pandemic continues to impact the world, this has raised concerns about economic recovery. Asset price inflation, even when monetary policy remains unchanged, is increasingly unsustainable, leading to the risk of a systemic retracement in global capital markets.

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