With markets down around 10% in 2015 it could be argued that this is not yet a true crash. Investors appear to be so conditioned to upward gains that they consider even a small correction as a major crash.

Yet, it is recent price action that experienced investors are most worried about and the omens are not good.

Mainstream Media Get It Wrong Again

As I have said many times before in articles, books, and courses, the mainstream media cannot always be relied upon to report the goings on in the financial markets with any degree of accuracy.

The main issue is that financial journalists are paid to report on market events and they’re told that they must always find an explanation or a fundamental reason for why something has occurred.

For example, if the S&P drops half a percent throughout the course of the day, the media will find a reason for it – perhaps a lower than expected retail sales number, or perhaps a hawkish comment from a central bank official.

The truth, however, is that markets ebb and flow due to the laws of supply and demand. Price follows the path of least resistance and there is not always any fundamental reason to explain its movements.

Of course, reporters will not admit to this because it is exceedingly dull. No-one wants to read up about how the stock market fluctuated up or down all day due to the interactions between buyers and sellers.

Occasionally though, market events can be explained.

For example, it’s reasonable to conclude that when the Federal Reserve cuts interest rates, the proceeding stock rally is a direct result. Or when Apple shares surge 10% after an earnings report, it can be concluded that the reason is because the company has managed to defy analyst expectations yet again.

In general then, the bigger the market event, the easier it is to explain. However, that is not always the case, and this is clearly shown by the reporting of the latest stock market crash (if you can even call it that yet).

The Market Crash Is Not About China

If you were to believe any of the mainstream media outlets you would think that the latest market crash is predominantly about turmoil overseas and a slowdown in Chinese economic growth.

According to most news outlets, US stock markets fell as a direct result of volatility in Chinese equities. The sell-off in China had a spillover effect on US markets and this selling only intensified after Chinese officials moved to devalue the yuan.

However, although events in China have certainly contributed to the crash, there is much more to this story. And here are some reasons why:

1. Chinese stocks have been falling for months

The first reason you can argue that this market crash is not predominantly about China is the fact Chinese stocks have been selling off for months, and this has had hardly any effect on US markets up until now.

As you can see from the chart below, Chinese stocks (orange line) peaked in early June before dropping over 40% over the course of the next two months. The S&P 500 meanwhile has traded in a flat range for most of 2015 and only started to fall last week. Therefore, if this was really about China, we would have seen the S&P 500 fall much earlier.

chinese stock market vs S&P 500 market crash

The fact is, China may be experiencing a slowdown but the country is still growing at a rapid rate of 7% a year. Even if the number is closer to 5%, this is still a long way off a crisis. The US can only dream of this type of growth and the Chinese central bank still has plenty of ammunition left (in the form of monetary tools) in order to boost growth – something that the Federal Reserve cannot claim.

2. Devaluation of the yuan didn’t cause the crash either

The chart above also shows how US markets really started to drop on the 19th and 20th August. The explanation that the stock selloff was caused by China’s devaluation of the yuan therefore also seems off base.

The yuan devaluation took place on Wednesday 12th August, seven full days before US shares started to slide. In fact, US stocks managed to shrug off the yuan devaluation on that day and ended up closing in positive territory. Why would they close higher if the devaluation was such a negative event?

yuan devaluation and the S&P 500 stock market crash

Again, the real truth is different to what is being reported by the media. A 3% devaluation of the yuan is nothing in the grand scheme of things and it would have a relatively minimal effect on US companies.

This is especially true when you consider that the yuan has for a long time been significantly undervalued by virtue of being a completely fixed currency. A 3% devaluation is not a large move in this context and can not be a major cause for the recent stock sell-off.

What about the oil market?

Just as Chinese stocks have been falling for a number of months, oil futures have been sliding for even longer. There is a solid argument for oil falling in response to a slowdown in China, however, there is no evidence to suggest that the drop in oil has contributed to the stock market crash. Indeed, there is much stronger evidence that lower oil is bullish for stocks overall.

oil and stock market crash

Again, attempts to find explanations for the market crash are misguided and there is in fact a much simpler answer to all of this.

This is what really caused the crash

It is handy for reporters and politicians to blame recent market events on China and overseas. Politicians have a long history of passing the buck but the reality is that this crash is simply an old-fashioned market correction caused by the usual characters – supply and demand.

The market had not had a 10% correction in over four years and had been pumped up full of artificial money from the Federal Reserve putting it at all-time highs. With several years of impressive gains behind it, the stock market was always going to pull back at some point and everybody knew it. The question was simply a matter of timing.

Last week, when the Federal Reserve appeared noncommittal to the prospect of future rate hikes, leaving the decision open and potentially to the very last moment, investors realised that the bank may be hovering and losing confidence in the global economy.

This caused uncertainty among investors who now don’t know whether to expect a rate hike in September or no rate hike for some time. Uncertainty, combined with other events, caused investors to sell and thus the first wave of selling began.

This selling quickly intensified as investors bailed out of their investments knowing full well that a correction had been on the cards for some time. This of course led to more selling, a lack of liquidity and a snowball effect. Many automated trading programs were likely turned off and the stock market simply took the path of least resistance.

What now?

As a result of the snowball, and with fears of 2008 still on investors minds, we have the potential for a prolonged market crash and it could be some time before investors have the confidence to move back into the market. Margin calls and illiquidity means that markets often overshoot and as Mohammed El-Erian has said, stocks could have a long way to go from here.

No doubt there will be bargains to be found amongst the rubble and there will be plenty of short-covering rallies along the way too.

It might be a long time before the dust settles and watching the actions of the Federal Reserve will continue to be critical for investors.

One thing’s for sure though, you can’t blame China for this one.


Summary
Article Name
Stock Market Crash 2015 Not About China
Description
As a result of the snowball, and with fears of 2008 still on investors minds, we have the potential for a prolonged stock market crash in 2015.
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