September 2, 2015

China Turmoil Spreads; Volatility the New Norm

SMITH BRAIN TRUST -- After August marked the Dow’s worst month, September opened with U.S. stocks plummeting upon fresh data showing China manufacturing contracting. The New York Stock Exchange subsequently invoked a rarely used rule designed to quell the turbulence, which spiked a week earlier after the China stock market posted its largest fall since 2007. Get accustomed to the volatility as the new norm in the global economy, Anil K. Gupta, the Michael Dingman Chair in Strategy, Globalization and Entrepreneurship at the University of Maryland’s Robert H. Smith School of Business tells CCTV America.

Meanwhile, U.S. energy and mining companies are taking the hardest hits, says Smith finance professor Michael Faulkender. “The softening of international economies leads to price reductions in things like oil and minerals used in production,” he says. “If oil prices drop, the companies that extract oil will see significant value reductions, as we are seeing.”

Gupta says the growing volatility is symptomatic of an “increasingly more tightly coupled world economy” that's becoming more multipolar in terms of multiple centers of economic power. In a system "where the nodes become as big as each other and are increasingly tightly connected, you’ll have high turbulence because a crisis in any part of the global economy will ripple through the entire world economy very rapidly,” he says.

Moreover, Faulkender says, large U.S. companies have significant overseas operations, and international growth drives their forecasted earnings growth. “Indications that foreign markets are slowing is bad for growth prospects, leading to revaluations,” he says.

Even without the Chinese slowdown, U.S. valuations have been high recently, Faulkender adds. So it’s reasonable that market shocks, “like the unanticipated devaluation of the yuan, may be a coordinating event for investors who have been anticipating a correction.”

Counterproductive Interventions 

Gupta says that the currency devaluation is “in line with what the market forces are signaling.” On the other hand, interventions by the Chinese government to prop up the stock market are problematic as they prevent the stock prices from finding their correct levels while also preventing investors from learning the right lessons.

Earlier in the summer, regulators tried to limit borrowing only to reverse the policy. They have provided cash to lenders, suspended initial public offerings and banned major shareholders of companies from selling shares for six months. Recent investigations by Chinese authorities into the stock market, reports Reuters, are spreading fear among China-based investors, some of whom have been summoned to explain trading strategies to regulators every two weeks.

Overall, “China has spent $200 billion trying to prop up the market -- to no avail,” says Smith Center for Financial Policy assistant director Kristen Fanarakis. “China’s reserves are estimated to be around $3.65 trillion, so in theory they have plenty of money to prop markets up, but reserves can dwindle quickly in a crisis,” she says.

Such failure in itself is creating a bit of a panic among global investors. “The end of summer trading volumes only amplify this volatility,” she says.

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About the University of Maryland's Robert H. Smith School of Business

The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and flex MBA, executive MBA, online MBA, business master’s, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.

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