The global stock market rally has hit a rough patch, as surging bond yields, rising energy prices and worries over China’s economic slowdown have dampened investors’ appetite for risk. The MSCI All Country World Index, which tracks shares across 50 countries, is down nearly 6% from its recent highs, though still up 10% for the year. The S&P 500, the benchmark index for U.S. stocks, is down about 5% this month, as is Europe’s STOXX 600. Japan’s Nikkei has slid just over 5%.
Bond yields spike on growth and inflation expectations
One of the main drivers of the market turmoil is a sharp rise in bond yields, which reflect the cost of borrowing money in the global economy. Bond yields have surged as signs of stronger-than-expected growth in parts of the world, such as the U.S. and the U.K., have fueled bets that central banks will start to raise interest rates sooner than expected to keep inflation under control.
Yields on the benchmark U.S. 10-year Treasury hit their highest since October on Thursday, reaching 3.25%. Meanwhile, U.S. real yields, which show what investors can expect to earn on government bonds after adjusting for inflation, stand near their highest point since 2009. Yields in other economies have also pulled higher. Britain’s 10-year real yield, for instance, on Thursday rose to its highest since last October.
Higher bond yields pose a threat to stocks in several ways. First, they make stocks less attractive relative to bonds, especially when stock valuations are already high by historical standards. Second, they increase the cost of capital for companies and consumers, making it more expensive to borrow and invest. Third, they can strengthen the dollar, which hurts U.S. exporters and emerging markets that rely on dollar-denominated debt.
Energy prices soar amid supply crunch and demand recovery
Another factor that is rattling investors is the surge in energy prices, which reflects a combination of supply constraints and demand recovery. European gas prices have jumped 36% so far in August, set for the biggest monthly increase since November. Oil prices are not far off nine-month highs, trading above $80 a barrel.
The rise in energy prices has several implications for the global economy and markets. On one hand, it signals that economic activity is picking up after the pandemic-induced slump, boosting the prospects of energy producers and related sectors. On the other hand, it adds to inflationary pressures, which could force central banks to tighten monetary policy more aggressively than anticipated. It also raises the cost of living for consumers and businesses, squeezing their disposable income and profits.
China’s slowdown weighs on global growth outlook
A third source of market anxiety is the slowdown in China’s economy, which accounts for nearly a fifth of global output and is a major driver of global trade and commodity demand. China’s growth has been hit by a series of shocks in recent months, including a regulatory crackdown on its tech sector, a debt crisis at its property giant Evergrande, and a resurgence of COVID-19 cases.
China’s official data showed that its gross domestic product (GDP) grew by 7.9% year-on-year in the second quarter of 2023, down from 18.3% in the first quarter. However, some analysts believe that China’s actual growth rate is much lower than the official figures suggest, citing weak indicators such as electricity consumption, industrial production and retail sales.
The slowdown in China has spillover effects on the rest of the world, especially on countries that depend on China’s demand for their exports or investment. It also poses a risk to global financial stability, as China’s debt problems could trigger a wave of defaults and contagion across its banking system and capital markets.
What’s next for investors?
The market turbulence has raised questions about whether the global stock rally has run out of steam or whether it is just a temporary correction that offers an opportunity to buy the dip. Some analysts argue that the fundamentals of the global economy remain strong, supported by vaccination progress, fiscal stimulus and pent-up demand. They also point out that corporate earnings have been robust and resilient, beating expectations in most regions and sectors.
Others are more cautious, warning that the risks of higher inflation, tighter monetary policy and slower growth are not fully priced in by the markets. They also note that investor sentiment has become too complacent and optimistic, leaving little room for disappointment or surprise.
Ultimately, the direction of the markets will depend on how the various forces affecting the global economy play out in the coming months. Investors will have to weigh the benefits of stronger growth against the costs of higher inflation and interest rates. They will also have to monitor how China manages its economic challenges and how it affects its trading partners and rivals. And they will have to cope with any potential shocks or uncertainties that may arise from geopolitical tensions, natural disasters or new variants of COVID-19.
