The fact that stock markets were off to such a dismal start during the first month of the year was enough to have some investors wondering if another global recession is looming. The S&P 500 index has managed to wipe out approximately $2 trillion in market capitalization over just a few weeks, echoing similar declines in other equity markets.
Meanwhile, crude oil has slumped below $30/barrel on fears of a supply glut, exacerbated by the lifting of Western sanctions on Iran and allowing the country to return to the oil export market with a vengeance. This, and concerns about an ongoing slowdown in China, have posed more uncertainties on the financial markets, leading many to believe that the worst isn’t over yet and some are talking of global recession in 2016.
What the gurus are sayingabout potential Global Recession
According to expert investor George Soros, some of these financial market signs are already pointing to the possibility of a global recession. “When I look at the financial markets, there is a serious challenge which reminds me of the crisis we had in 2008,” he was quoted saying around the second week of January, before stocks chalked up yet another week in the red.
“China is struggling to find a new growth model and its currency devaluation is transferring problems to the rest of the world,” Soros told the Sunday Times in Sri Lanka, adding that financial markets are “facing a crisis and investors need to be very cautious.”
US investment bank Morgan Stanley supported this grim view, citing that softer demand among developed economies and a likely slowdown in emerging nations could be a recipe for another global recession. The banks’ analysts predict that the probability of this taking place is as high as 20% in the worst case scenario, as capital outflows from China could worsen the situation.
Unwinding of risk and stimulus
Although the numbers are showing that the world’s top economies have managed to make it out of years’ worth of negative GDP readings, this has mostly been a result of an era of low interest rates and massive stimulus programs. Recall that several central banks decided to loosen their monetary policy in order to spur lending and spending activity.
This, in part, has fueled a stellar rally in stock markets as investors used the additional liquidity to buy shares of companies at cheaper levels back then. As the global economy gained momentum, speculative buying paved the way for much stronger rallies and even more capital infusion.
However, as the US Federal Reserve has already begun to take these easing measures off the table by hiking interest rates in December, many are worried that the positive momentum might soon be reversed. This is also the case in other economies which have mostly relied on central bank easing to shore up their economic performance.
Now that the growth momentum appears to have lost steam, it’s unfortunate that central banks have used up most of the firepower in their monetary policy arsenal, leaving them with very little options left in case their economies need more support. Interest rates are still very close to zero, with the European Central Bank and Swiss National Bank actually keeping negative deposit rates in play, while asset purchase programs could prove to be unsustainable.
2008 vs. 2016: Housing bubble vs. Chinese bubble
Back in 2008, it was mostly the over-leveraged positions in mortgage-backed securities that served as the tipping point for the financial recession in the US, sending repercussions all over the world. This time around, the bubble could burst from China, the world’s second largest economy.
In mainland China, investors are mostly restricted to putting their money in real estate and stocks, creating a boom in both housing and equities over the past years. However, it wasn’t long before this speculative positioning led to overvalued investments and the supply is starting to outweigh demand.
A few signs of the bubble getting ready to burst have emerged, but the Chinese government and central bank have been busy implementing measures and capital controls to limit potential declines. The People’s Bank of China has lowered the reserve requirement ratio and lending rates in order to spur more borrowing activity, which might then convince the large middle class population to put this money back in real estate and the stock market.
The government has also imposed measures that curb short-selling among major stockholders, thereby keeping a lid on bearish positions that could accelerate any declines. In a few instances, officials have also halted trading on major exchanges in order to stop the bleeding. However, these measures can only go so far before weak fundamentals catch up to China, and a bubble bursting could drag the rest of the world economy down to the brink of a global recession.
Oil and commodity rout
Another factor that is keeping global growth prospects weak is the slump in oil prices, which actually started in late 2014 then resumed towards the end of last year onto this year. So far, the OPEC oil cartel has refused to curb production in order to ease fears of a supply glut and boost prices, and the return of Iran to the oil export market now that its nuclear program sanctions are lifted could mean more losses for the commodity.
Of course this has widespread effects on other commodities and overall consumer inflation, as this could mean a wave lower in food and transportation costs. Nations have barely recovered from their brush with deflation last year yet another set of downward price pressures are in play, keeping the prospect of stagflation on the horizon.
On a more upbeat note, the US economy appears to be very resilient amid all this, but it remains to be seen how company profitability and consumer confidence can hold up in a period of higher borrowing costs. At the end of the day, it’s also important to note that recessions are part of the ebb and flow of the macroeconomic cycle. With the last one taking place more than seven years ago, it wouldn’t be surprising to see another one waiting in the wings.
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