QUESTION 1: MARKET CONTAGION It is said that global stock markets are intertwine
ID: 2773267 • Letter: Q
Question
QUESTION 1: MARKET CONTAGION
It is said that global stock markets are intertwined/connected and that market performance in one part of the world could have fundamental impacts or influences on the markets in other parts of the world (contagion). This phenomenon was recently exhibited across the markets in Asia and the developed states in Europe and North America.
Required:
Provide an account of the performance of the major global markets in the last 3 months to date, commenting of how stock markets performance in Asia impacted on the stock markets in Europe, North America and to an extent markets in Africa (at a secondary level). Clearly outline the reasons that were responsible for the stock market declines (fall in stock market indices).
Explanation / Answer
The last three months have exhibited a major Market Contagion caused by the falling Chinese stock markets with its direct impact on America and Europe.
China has missed its official growth target of 7.5%, and its consumer inflation hit a near five-year low of 1.5% in December, according to BBC News.
Investors have been piling in, encouraged by falling borrowing costs as the central bank loosened monetary policy.
Unlike most other stock markets, where investors are mostly institutional, more than 80% of investors in China are small retail investors. The rise was also fuelled by a switch away from property investment following a clampdown by the government on excessive lending by banks. Laws liberalising the stock market also made it easier for funds to invest and for firms to offer shares to the public for the first time. The past six months have seen a record number of businesses listed on the Shanghai and Shenzhen exchanges.Beyond Asian markets, investors in Australia are also starting to feel the effects of the Chinese slump. Australian stock markets have sold off on the back of the Chinese market turmoil and falls in commodity prices. The worry is focused on Australia’s miners, because demand for Australian iron ore and coal will fall if theChinese economy suffers.
The spectacular growth of China included the phenomenon of expanding large trade surpluses with major industrial countries. One such unique relationship is that with the US. Large trade surpluses with the US have led China to amass huge financial savings. In turn, these savings enabled China to become a major creditor of the US, because the latter had large fiscal deficits. China has become the highest holder among foreign countries of US debt.
A renewed collapse of tech stock prices on China’s tech-heavy Shenzhen stock market will almost certainly result in an effect on US tech stock prices as well. And there are real economic contagion effects as well as financial. As money capital flows from China back to the US and the west, it will drive up the US dollar. That will further limit US exports, which are already contributing negatively to US GDP. China also buys about $100 billion a year in US exports. But as China consumption contracts due to the stock collapse, fewer US exports will be purchased, thus slowing the US economy still further.
The same applies to China purchases of European exports, as Europe struggles to get its faltering economic engine going. Furthermore, as the US dollar rises, the global price of oil tends also to decline. Tens of thousands workers are already being laid off from work in the US oil-shale sector and business spending there is plummeting, further slowing US growth. Emerging market economies—Russia, Nigeria, Indonesia, Venezuela—all highly dependent on oil exports, will slow economically further as well. Emerging market economies like Brazil, Peru, South Africa will experience still slower growth and more financial instability as their exports of commodities and other goods to China slow and as their ability to finance imports declines in turn.