Causes of the Global Market Sell-Off

Robert Hsu, July 07, 2008

Over the past couple weeks, we've talked a lot about the volatility in the world's markets. And for good reason. Year to date, the U.S.'s S&P 500, Hong Kong's Hang Seng index, Japan's Nikkei index, Australia's benchmark index, and India's stock market are all down year to date. And not to mention that Chinese stocks listed overseas have sold off about 25% this year.

With so much doom and gloom in the markets right now, I think it's important to take a closer look at what is contributing to the current global sell-off. So lets dive into the issues that are weighing down the markets, as well as what my outlook is on them.

Right now, I would say that the three main causes for the global market sell-off -- with a particular focus on China -- are: 1) Sky-high energy prices; 2) China's tight monetary policy; and 3) The continuing credit crisis. Here's a look at all three.

Record energy prices: Crude oil prices have hit a record $140 a barrel recently, and they are set to move even higher in the months to come. This is especially true because current oil production in the Middle East – a main source for oil -- can no longer increase production in any meaningful way, since their current oil reserves have matured and are being tapped out.

So to meet the world's rising energy demands, new oil reserves need to be discovered. And the prime place explorers are looking is deep underwater. However, even giant oil companies' explorations are being hindered by the fact that underwater oil fields are too expensive to develop. So not many companies have tried tapping into this oil source.

Also pressuring limited oil supplies is increasing demand from Asia, which has greatly contributed to the 40% increase in crude oil prices this year. Now, some of the oil that was exported to the U.S. last year is now being sent to Asia.

When do I expect oil price to top out? A good guess is the summer of 2009 -- just before the estimated completion date of Burj Dubai, the new tallest building in the world located in the oil-driven state of Dubai. History shows an uncanny correlation between projects to build the tallest buildings and economic crises. Be it in Taipei in 2004, Kuala Lampur in 1997, Chicago in 1974 or New York in 1930, architectural hubris has been a strangely reliable contrary indicator of the peak of an economic crisis.

Tight liquidity and market correction in the Chinese stock market: Beijing has been battling high inflation all year. The government there has taken some strides to tame the inflation rate by increasing interest rates and raising reserve requirements. But this policy has contributed to the decline of the Mainalnd Chinese stock market.

You see, inflation has contributed to this index's 60% fall from its peak last October. And even the much cheaper Chinese stocks listed in Hong Kong and New York that we follow have been hit -- they have sold off 45% from their highs.

While the drop in the Chinese market has been shocking, keep in mind that these stocks rallied 100% between last August and October. These stocks just moved too high, much too fast, so a sharp correction was bound to come. ,And, making matters worse, these stocks then became vulnerable to collateral damage from the volatility in the U.S. and Mainland China stock markets.

Despite selling off and the interest rate hikes in Mainland China, Hong Kong-listed stocks still are enjoying robust earnings growth. Plus, I think that the selling in Mainland China is near the end, and as the Beijing Olympics approach, market sentiment will likely improve in July.

Financial services industry woes continue: Banks and brokerage firms are still reporting more bad debt write-offs and sharply weaker earnings. Currently, banks and brokerage firms have booked over $400 billion in write-offs and losses from credit market problems. And losses from credit market deterioration will probably top $1 trillion. This has played a big part in dragging down U.S. earnings.

But at this time, I think most of the bad news has been discounted by the market. And after these write-offs are over and the capital injections are finalized, I think that we have probably already seen the worst. A recovery in financials is important for the U.S. stock market's overall momentum, so it is good that these banks and brokerages are raising new capital to offset their losses. Once they do, I think that the financial markets will see brighter days.

Even though the days can be rough for investors, there are still ways to make money right now. In fact, I have an oil play that is rolling in dough, and so are my subscribers. To learn more about it, join China Strategy today!