The thing that struck me the most about yesterday’s global market selloff, is the sense of déjà vu. The more things change, the more they stay the same:
This is from the cover of the November 1 issue of The Economist magazine – November 1997, that is. At the time, as now, emerging market currencies and capital markets were under enormous pressure. Then, as now, the USD was on a multi-year bull run:
Then, as now, the Fed was right at the start of a tightening cycle (which was short-circuited by the emerging markets crash).
The big difference, at least for us in Malaysia, is that our economic fundamentals now are much stronger. In 1997, the economy was very obviously overheating from a massive credit and real estate bubble – loan growth had exceeded 20% in the two years prior to the AFC. Excess demand was turning up not in inflation, but in asset prices. The current account was in deficit, and international reserves were miniscule. Worst of all, the currency was soft-pegged to the USD and the REER was dragged upwards with the USD’s appreciation. None of these conditions apply in the Malaysian economy circa 2015.
This time around, we’re looking at the consequences of someone else’s sins. Many have been wary of the fallout from China’s post-GFC stimulus, and the Yuan’s devaluation two week’s ago was a signal that all was not well in the Middle Kingdom.
Nevertheless, this is as much about market psychology as it is a fundamental story of a mismatch between prices and underlying supply and demand. You don’t get this kind of panic – and yes, it was a panic (bid-offer spreads on the Ringgit yesterday were ridiculous) – without prices moving well beyond what’s justified.
From my point of view, investors sold because market prices were indicating that others were selling. Some fund managers sold because they were facing redemptions from their investors, while others had holding limits which constrained their holding power, meaning they couldn’t ride out a market downturn. But my thinking is that it’s mostly, I need to sell before the others do.
Nobody wants to be left holding the bag. It’s a case of I know, that you know, that I know, that you know ad nauseam. It’s perfectly rational – and yet totally irrational. It takes a lot of discipline and focus to ignore the noise, ignore the fear and emotions, to go against the crowd.
I’m not sure that even taking the human element out of it would change things much – the same behavioural rules would likely apply to trading algorithms (risk limits, investment horizons etc). If all programs act the same, you’ll still see the same herd-like behaviour in market prices.
The more things change, the more they stay the same.