Chinese stocks suffered the biggest sell-off overnight in more
than four years as the short-term funding issue in that country's
banking sector is morphing into a cash crunch for the economy.
The Chinese central bank could very easily address the issue, but
it is reportedly staying on the sidelines with the explicit goal
of shaking out the shadow banking sector, which had become a
source of aggressive credit creation in the economy.
We will see how this issue unfolds in the coming days, but
this funding issue adds to the growth questions about China that
the markets were already trying to grapple with. Growth estimates
for China's GDP have started coming down lately which is having
knock-on effects in a range of commodity markets.
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China may be in the headlines today, but the biggest source
of market volatility at present is the Fed's changed monetary
policy stance. The spike in benchmark treasury yields is the most
tangible outcome of this changed backdrop. The Fed's QE program
kept interest rates low, by some estimates roughly half the level
where they would be otherwise. Interest rates still remain low by
historical standards, but the 'normalization' process has been
very swift thus far - an almost 100 basis points jump for the
10-year treasury bond yield in the last few weeks. Higher yield
levels by themselves may not be that destabilizing, particularly
for a recovering economy. But the speed with which yields rise
could be problematic and that's what has the markets most
unnerved at this stage.
The consensus view appears to be that there is not much downside
to this trend - that stocks have dropped about 5% from the May
high and will drop a few more percentage points to roughly in the
1550'ish level for the S&P 500 index. To back up this view,
all kinds of technical support levels and moving averages get
cited. May be these folks are correct, but I am a lot less
sanguine about the market's near-term trend.
I don't see the market stabilizing till it reaches the low
1400's, may be even a bit lower. Investors overlooked the lack of
earnings power over the last few quarters with the help of QE.
But with that prop no longer available, they can't escape the
reality of a very underwhelming earnings picture. Multiple
expansion gave us the rally, but that is now firmly in the
rearview mirror. The gains going forward will need to come from
earnings growth. But unfortunately the earnings growth story may
have already played out as well.