Some commentators have rushed to describe the recent global stock market turmoil as “historic” and “unprecedented,” yet its evolution has been quite traditional so far.
What may be different this time, however, is whether longer-term stability can be restored with the policy tools that were available in the past.
This selloff started as a repricing of global growth prospects. Mounting evidence of economic weakness in the emerging world, along with persistent low growth in Europe and Japan, made it hard for markets to ignore the impact on earnings and profitability of a global slowdown.
The selloff accelerated as fears spread that policy makers may not be able to respond sufficiently quickly and effectively. Part of this worry had to do with the extent to which central banks have depleted their ammunition stores after years of carrying the bulk of the policy burden. But a more significant concern arose from the correct realization that the primary response would have to come from the emerging economies that are the source of the growth and financial concerns this time, and not from the Federal Reserve and the European Central Bank.
As is often the case, the selloff further gathered steam when traders realized that policy circuit breakers would not materialize immediately. The rout became disorderly for a short while when classic deleveraging technical forces, including forced generalized selling by volatility-sensitive investors and over-extended portfolios, took hold of the markets. The result was the conventional mix of price air pockets, valuation overshoots and contagion.