(Bloomberg View) — The 7 percent rout that compelled China to halt stock trading on Monday, along with sharp losses in European and U.S. markets, marked an inauspicious beginning to the new year for investors.
Here are the five things to know about the implications of the selloff for 2016 and beyond:
1. The two main causes were renewed warning signs about the health of the Chinese economy and a new flare-up of geopolitical tensions in the Middle East, which intensified concerns about the strength of fundamentals underpinning financial asset prices.
Specifically, these signals highlighted the fragility of a global economy that has yet to develop sufficiently robust growth engines. They also were a reminder that markets are vulnerable to geopolitical stresses that extend well beyond nation-states and can involve non-state actors whose disruptive behavior is hard to predict, let alone control.
2. Investors followed the initial large and precipitous falls in equity prices with buy reactions that were consistent with years of repeated conditioning.
In China, the government stepped in again with measures to stabilize market sentiment; and it did so even as it had been planning to phase out its previous intervention. In Western markets, some private stock purchasers came in looking for bargains, following an ingrained pattern created by years in which "buy the dip" strategies have proved quite profitable.
3. This response reflects market expectations of subsequent liquidity injections from two sources: exceptional central bank policies, including large-scale asset purchases (or quantitative easing); and companies deploying their cash holdings via stock buybacks, higher dividends and merger and acquisition activities.
Yet as reliable as these reactions have been in the past, their immediate applications are more uncertain today. After the December rate hike by the Federal Reserve, the systemically important central banks are now on divergent paths.
Specifically, the Fed is easing off stimulus policies while others — including the Bank of Japan, the European Central Bank and the People's Bank of China — are likely to accelerate such measures. Meanwhile, the immediate deployment of company cash is hindered by the approach of the quarterly earnings season, when corporations tend to be less active.
