Global stock market meltdown

On the morning of August 5th, 2024, the global stock screen went red indicating a global stock market meltdown had started. Some news channels and papers were already taking and publishing articles referencing this event as Black Monday (which was a catastrophic stock market meltdown that happened on October 19th, 1987). The question that puzzled me was, What is happening? And why is it happening? The following article gives answers to those questions.

Highlights

1. Japanese Market Reaction: The BOJ’s interest rate hikes ended a 13-year period of negative rates, disrupting the carry trade and triggering market volatility.
2. US Tech Sector Drop: A $1 trillion loss in the US Tech sector in late July heightened market volatility, influenced by the performance of major tech stocks.
3. Recession Fears: An inverted yield curve, Sahm Rule trigger, and rising unemployment rate are fueling recession concerns among investors.
4. Middle East Tensions: Geopolitical risks and conflicts in the Middle East, combined with rising oil prices, are exacerbating global market uncertainties.

Phase 1 — Japanese Market

Since January 29th, 2016, the Bank of Japan (BOJ) interest rate has been at -0.1%, which means that the Bank of Japan was paying people to borrow money, which was done to stimulate the flow of money in the Japanese market. However, on Mar 19th, 2024 BOJ increased their interest rate. But it wasn’t just that, this was the first time that the interest rates were at the levels of October 5th, 2010. So that means, for almost the last 13 years the BOJ has not raised interest rates. This was the first domino to move, however, in the next 4 months on July 31st, 2024 the BOJ raised rates again to 0.25% which dropped the second domino in the chain of events.

Figure 1 BANK OF JAPAN RISING INTEREST RATE FOR SECOND TIME
SOURCE: TRADING ECONOMICS

Figure 2 NIKKEI INDEX DROP IN THE FIRST WEEK OF JULY.
SOURCE: YAHOO FINANCE

During the negative interest rates, Japanese people realized that there was no way they could make money by keeping money in the banks. Thus, they started borrowing money and investing it in countries with appreciating currencies. This would add value to their trade and the difference between appreciated value and invested value would be their profit. This type of trading is called Carry Trade. For years not only Japanese people but also many institutional investors, hedge funds, banks, etc. implemented this model to make money. However, when the BOJ started raising interest rates (Figure 1), things started to stall, clearly because now borrowing Japanese Yen was not as feasible as before.

The second increase in the interest rates from BOJ induced a panic in Japanese market which resulted in a drop during the end of July (Figure 2).

Phase 2 — US Tech Sector

The US Technology Sector has grown its contribution towards the S&P 500 index due to the constantly increasing market cap of companies within this sector, refer to Figure 3 data sourced from (https://einvestingforbeginners.com/historical-sp-500-industry-weights-20-years/).

Figure 3

Recently Magnificent Seven (AAPL, MSFT, TSLA, AMZN, META, NVDA, GOOGL) have played a vital role in the huge up move in the US market. An article, “A Closer Look at Magnificent Seven Stocks”, published by Stephanie Hill, talks about how these seven stocks have been performing since 2023, the article was published in Feb 2024 thus the data is limited to that time. This brings us the second domino, a $1 Trillion drop in the US Tech Sector during the last week of July. This induced high volatility in the sector. This brings us to the next chapter where we would introduce the catalyst that aided the meltdown.

Phase 3 — US Economic Recession Fear

Here we look at three prominant indicators which can help us understand the recession fear.

1. Yield Curve?
   In Figure 4 is a plot of 10-year Treasury yields minus 2-year Treasury yields. In simple terms, it gives us a view of what outlook can investors have towards the Treasury Bonds yields in the long-term and short-term. When the curve is above 0, it means that the outlook on long-term bond yields is higher than short-term, however, if the value is below 0 the outlook gets inverted. An interesting pattern to notice here is when the curve gets inverted the probability of recession is increased as this indicates that the investors are moving money away from short-term bonds to long-term ones. This suggests that the market as a whole is becoming more pessimistic about the economic prospects for the near future.

Figure 4 YIELD CURVE NEAR ZERO
SOURCE: FEDERAL RESERVE ECONOMIC DATA

As of August 8th, 2024, the yield curve is very close to 0, reading at -0.05. This close value puts investors in a position to activate risk management measures and look at other indicators to get a better picture of the situation. This brings us to the Sahm Rule.

2. Sahm Rule
Claudia Sahm is a renowned macroeconomist who worked for the Federal Reserve Board and has served as a Senior Economist at the Council of Economic Advisers for the Obama administration, where she worked on macroeconomic developments and housing policy from 2015 to 2016. Sahm developed an indicator which is used worldwide to anticipate the upcoming recession, Figure 5 shows the indicator and also past recessions which gives us a better picture of the timing of this indicator.

Figure 5 SAHM INDICATOR GOT TRIGGERED
SOURCE: FEDERAL RESERVE ECONOMIC DATA

On May 2023 Sahm indicator crossed the 0 line, however, the start of the recession signal was triggered from the July 2024 data when the value read 0.53%.

3. Unemployment Rate

Figure 6

Unemployment rate (Figure 6) is an important factor that goes in the Sahm rule and also a crucial indicator to look out for upcoming recession. In July 2024, the unemployment rate in the United States increased to 4.3%, up from 4.1% the previous month. This is the highest rate observed since October 2021 and surpasses market predictions that it would stay at 4.1%. The number of unemployed individuals grew by 352,000, reaching a total of 72,000,000. Meanwhile, net payrolls saw a modest rise of 114,000, falling short of the expected 175,000 increase. Additionally, the labour force participation rate inched up to 62.7% from 62.6% (Source: Trading Economics).

This combinative flurry of inverting the yield curve, triggering of Sahm Rule, and increasing the Unemployment Rate ignited the spark of recession fear among investors. However, there are even more indicators that one can choose to look at to anticipate the upcoming recession.

Phase 4 — Middle East Escalation

Rising tension in the Middle East raised the geopolitical risk within the market. Stock markets in the Middle East fell on Monday due to concerns about the US economy heading for recession and a widening conflict in the region. The US unemployment rate jumped to near a three-year high of 4.3% in July, heightening fears of a recession. Dubai’s main share index plunged 4.5%, its biggest intraday fall since May 2022, dragged down by a 7.6% slide in blue-chip developer Emaar Properties. Abu Dhabi, Saudi Arabia, and Qatar also saw declines in their main share indexes.

Figure 7 CRUDE OIL PRICES ON RISE
SOURCE: TRADING ECONOMICS

The non-oil private sector in the UAE expanded at its slowest pace in almost three years in July. Oil prices eased as concerns about global energy demand offset worries about the potential impact on supply (Figure 7). Israel and the US are bracing for a serious escalation after Iran and its allies Hamas and Hezbollah pledged to retaliate against Israel for the killings of Hamas’s leader and a top Hezbollah military commander last week. This is the entire article.

Figure 8 MIDDLE EAST REGION GEOPOLITICAL RISK INDEX
SOURCE: MacroMicro

In Figure 8, we can see the latest data from the Geopolitical Risk (GPR) Index for the Middle Eastern region (the data is published by MacroMicro). Israel and Egypt seem to have higher-than-average values for July, however, the strength seems to be decreasing it appears as if the recent events could raise the tensions again.