The first week in November racked up more red numbers across the board in Asian stocks, extending the volatility and uncertainty into a second month following losses in October.
The end of the uncertainty around midterm elections in the US saw a slight rebound but this was soon followed by more losses in US and EU stock markets. The main drivers of the overall downward trend are weaker third-quarter growth in China due to the trade tensions with the US, and fears of contagion reaching the world economy. In Europe, Italy’s zero growth and growing fiscal spending are making investors nervous of a potential default and bailout.
As global stocks struggle to recover from October’s turbulence, more unnerving news broke from Beijing, threatening to exacerbate the bear market for major indices like the Shanghai Composite. Markit reports the Caixin China services PMI slipped to a 13-month low of 50.8, just above contraction territory.
China’s economy is heavily dependent on services, which make up almost half of the country’s total GDP. The trade tensions between the world’s two largest economies come at a delicate time in China’s economic development. As the Asian giant moves from a closed, mainly agricultural economy to an open, service-dependent economy, a full-blown trade war could interrupt its progress to the detriment of the entire region.
The lesson for investors is that the trade talks between the US and China are all-important in the short-term outlook for Asia’s stock markets. Definitive action to impose high tariffs on imports has already been taken by both administrations, but America appears to be the first to blink as instability in the stock markets continues.
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President Donald Trump said he would make a great deal with China, lifting hopes the uncertainty over trade relations would end. It may be too late, however, given the bearish conditions in the Shanghai Composite and already-nervous animal spirits colouring the investment mood. The fall on November 5 was justified by many as profit-taking, but when it was followed by more sell-offs on November 9 this argument lost ground. When profit-taking is carried out in the context of a bear stock market, it only deepens the trend and the chances of another knock-on effect on US and European markets.
I've written in the past about the inevitability of a correction in US indices given the long bull run and over-valued stock prices. It was seen in October when the Nasdaq entered official correction territory. On top of that, rising interest rates and a hawkish Federal Reserve are triggering fears of higher borrowing costs and lower profits. In my opinion, this had a major effect on investor confidence, resulting in October’s sell-off in equities and the knock-on effect into November.
US stock markets appear to be at the delicate stage of escaping further pain or tipping over into correction market territory. A bear market could be avoided given relatively strong growth in the US, but the risk of further volatility still hangs over the stock indices. The crux of the matter is US protectionism, which appears to have reached the point of diminishing returns. The "America first" policy brought back factories to the US and grew the job markets, tax cuts benefited local businesses and tariffs on imports helped sell more locally made products.
But the policy was a 180-degree change from free trade, meaning a shock for which the country was unprepared for in the long term. Investors should monitor developments in US-China talks closely and be aware of the risks ahead.
Hussein Sayed is the chief market strategist at FXTM