Investment performance made most investors a bit grumpy by the end of 2015, given that virtually every asset closed the year down a bit. During 2016, grumpiness is giving way to fear.
Here’s how the year began:
- On the first trading day of the year, China’s Shanghai index fell 7% intraday. Traders fled, triggering circuit breakers after China reported a fifth consecutive month of weak manufacturing data.
- Saudi Arabia severed diplomatic ties with Iran in response to the storming of its embassy in Tehran. Bahrain also cut ties with Iran. Oil prices rallied on the news, but stock prices fell.
- Bad news in China plus bad news in the Middle East equals bad news everywhere and a sharp selloff in equity markets. European markets dropped more than 2% across the board, Dow futures were down nearly 300, and S&P futures were trading down more than 1.6%.
Things have only gotten worse since then. By the time the market closed on Thursday, the Dow Jones Industrial Average was down 911 points – a drop of more than 5% in just four days. That’s the worst four-day percentage loss to start a year on record, according to FactSet stats that go back to 1897. The Nasdaq index, meanwhile, was down more than 6%, its worst start since 2000.
Unraveling All At Once
Zerohedge, which de facto refers to “this latest global financial crisis,” says it is being caused because “a whole bunch of seemingly-unrelated things are unraveling all at once.” In contrast, the 2008 financial crisis was caused by a housing bubble, while the 2000 market crash was caused by a tech stock bubble. Today, you can choose your bubble.
“China’s mal-investment binge is crashing global commodities,” Zerohedge notes, “an overvalued dollar is crushing emerging markets (most recently forcing China to devalue), the pan-Islamic war has suddenly gone from simmer to boil, grossly-overvalued equities pretty much everywhere are getting a long-overdue correction, developed-world political systems are being upended as voters lose faith in mainstream parties to deal with inequality, corporate power, entitlements, immigration, really pretty much everything.”
If you’re looking to dissect this unraveling, China is a good starting place, as it provides a great lesson in what happens when the government seeks to control everything.
As noted above, China’s new circuit breakers cause trading to cease when the market drops 7%. In comparison, in the U.S., a drop of 7% in the S&P 500 Index triggers a 15-minute halt to trading if it takes place before 3:25 p.m. EST and it takes a 20% drop to cause a full halt to trading for the day.
China’s circuit breakers have already kicked in twice this year– on Jan. 4 and again on Jan. 7, just a half hour into the trading day.
Ironically, China’s new circuit breakers were installed to prevent investors from panicking, but they are having the opposite effect. Recognizing that they were causing more damage than they were preventing, regulators decided to suspend them a few hours into the trading day on Thursday.
Applauding the suspension, Andy Kapyrin, Regent Atlantic’s director of research, told Fox Business News, “It will remove the incentive to rush for the door on a down day. China created these circuit breakers last year, but the problem is they made them too tight. … Having a circuit breaker that’s too tight might make a crash more likely because it could make everyone run to an exit, but the door is only so big.”
$57 Trillion More Debt
While Zerohedge says the worldwide funk that’s started the year is being caused by unrelated geopolitical and financial issues, we disagree. In China, and throughout the world, it really does come down to one thing. It’s all about debt, which as the chart shows, has increased by $57 trillion since the financial crisis. 
It’s no coincidence that as debt has increased, economic growth has slowed down, not only in the U.S., but worldwide. Efforts by the Federal Reserve Board and other central banks to jumpstart economic growth by lowering interest rates failed to generate growth, but they generated plenty of debt, as borrowing money became cheap.
Now, though, that money has to be paid back. And, as interest rates increase, simply servicing the debt will in many cases become increasingly expensive.
Meanwhile, if this is really the beginning of another financial crisis, how will the Fed respond? Will the Fed reverse the tiny rate increase it just approved in December? Will it hold steady and pretend that the economy is continuing to improve?
The good news is that, with the Fed out of options, it will be up to President Obama and the U.S. Congress to fix the economy. The bad news is that, especially in an election year, the chances of that happening are close to zero.