Analysis: Behind the global stock market plunge of 2016

Global equity markets have been on a rollercoaster ride since the opening sessions of 2016. The violent lurch lower in stocks was initially triggered by fears that an economic slowdown in China, the world’s second largest economy, was spinning out of control.

But it was the spectacular collapse in oil prices that really lent impetus to the January sell-off.

“Fear, not economic fundamentals, sparked the frenzied sell-off in China as the new year got under way which then spread to global markets and the oil price slide has compounded the pessimism,” said Beijing-based economist Chen Chen, at the Economist Intelligence Unit.

WATCH: What’s behind China’s stock market meltdown?

China is in the midst of a shift from an economy reliant on exports and an infrastructure building binge to one based on economic consumption, and as a result asset prices around the globe are being revalued.

The world’s largest consumer of metals and second biggest buyer of oil posted its lowest annual growth in a quarter of a century in 2015.

It is not the slowdown itself that is posing the problem, say economists, but a lack of clarity over how the slowdown is being managed. 

Many point to confusion over Beijing’s currency management and lack of transparency over the policy road map ahead as the key problem.

Speaking at the World Economic Forum in Davos, the IMF managing director Christine Lagarde described the Chinese transition as a communication challenge.

Mark Williams, chief China economist at Capital Economic, said the credibility of China’s policymakers had been badly damaged by their “inept” interference in the equity market and their failure to communicate changes in currency policy.

According to Williams, the competence of the Chinese leadership matters, given the difficulty of the task it faces in steering the economy. And it is that uncertainty or fear which is sparking a chain reaction in stock markets around the globe.

Oil price shock

At the same time, crude prices have spluttered and skidded to below $30 a barrel in one of the most dramatic plunges in recent history.

“With Iran poised to unleash more crude on an already oversupplied market and Saudi Arabia’s refusal to cut production, there appears to be little in the way of relief in the near term for energy markets, oil dependent economies, energy companies and their bankers,” said Philip Shaw, chief economist at Investec.

Standard Chartered believes prices could fall as low as $10 a barrel before the rout ends.

“The dominance of this highly bearish view of supply and demand… means that the path of least resistance for prices will, absent a new catalyst, likely still be to the downside,” wrote Paul Horsnell, head of commodities research, in a note on January 11.

So, as the gloom continues, attention has focused on attempts by policymakers to soothe fears about flagging global demand weighing down inflation and growth.

The People’s Bank of China has been making record amounts of liquidity or money available to the short-term lending markets before the Lunar New Year celebrations, beginning in early February.

Soothing sounds from European Central Bank President Mario Draghi on January 21 helped markets to regain some traction after he signalled a policy review as soon as March.

Over in the US, the Federal Reserve announced on Wednesday that interest rates would remain unchanged at 0.5 percent, after raising the rate by 0.25 percent in December.

“The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labour market and inflation,” the Fed’s board of governors said in a statement.

The medicine applied to the world economy in the wake of the financial crisis has been a diet of low interest rates and easy money.

But seven years on, questions are now being raised whether the central bank cavalry really has any arsenal left to quell a fresh resurgence in global uncertainty.