CASE STUDY: GLOBAL STOCK MARKET CRASH AND FLIGHT TO SAFETY ...
CASE STUDY: GLOBAL STOCK MARKET CRASH AND FLIGHT TO
SAFETY, FEBRUARY 27, 2007
Tuesday, Feb 27, 2007: Stocks dropped and safe-haven government bonds
rallied around the globe on Tuesday after the biggest daily loss in a decade on
China's main stock market and soft U.S. manufacturing data sparked a pullback
China's government approved a special task force to clamp down on illegal share
offerings and investments with borrowed money after stock market indexes had
climbed to record levels.
In the U.S., the US Commerce Department said orders placed with U.S. factories
for durable goods slumped 7.8 percent following a 2.8 percent gain in December.
Orders excluding transportation equipment slid 3.1 percent. The US figures
suggest reluctance among companies to invest has carried into 2007. Bloated
stockpiles at auto dealers and construction-equipment makers may restrain
production early this year, Federal Reserve Chairman Ben S. Bernanke told
Congress this month.
On Tuesday, in China, the Shanghai Composite index plummeted 8.8 percent, in
part on fears Chinese authorities would crack down on the speculation that drove
the index to record highs this week. Other stock markets then fell like dominoes.
Over the last 12 months, leading up to Tuesday, the Shanghai Composite Index
had increased about 100%.
China's Shanghai and Shenzhen 300 Index slumped 9.2 percent, also from a
record. It had jumped 13 percent in the previous six sessions. The rout wiped out
$107.8 billion from the market value of China's companies, which had doubled in
the past year.
In currency markets, the Japanese yen surged after the jump in market volatility
caused market participants to rush for the exit from their carry trades -- a popular
strategy in which investors borrow in low-yielding currency to fund investments in
other higher-yielding regions.
"What we're really looking at here is a big move away from risk," said David
Durrant, currency strategist at Julius Baer Investment Management in New York.
"The big fall in Chinese stocks especially has got some people nervous about the
The sell-off in U.S. stocks was widespread, but shares of companies that rely
heavily on Chinese demand, including Caterpillar Inc. were among the biggest
U.S. stocks plunged, wiping out about $600 billion in market value and erasing all
of 2007's gains. The Dow Jones Industrial Average fell as much as 546 points,
the most since the first trading day after the Sept. 11, 2001, terrorist attacks in
New York and Washington. All but two companies in the Standard & Poor's 500
The plunge in China ``exposed the fact that there are problems developing,'' said
Jim Rogers, who co-founded the Quantum hedge fund with George Soros in the
1970s. ``When you have major stock declines, they always start in marginal
countries, sectors and companies.'' ``With capital flows being so global it's hard
for action in a large country like China not to have an effect on other markets,''
said Amanda Smith, who helps manage $6 billion at ING New Zealand Ltd. in
At its close, the Dow average sank 416.02, or 3.3 percent, to 12,216.24. The
S&P 500 retreated 50.33, or 3.5 percent, to 1399.04. The Nasdaq Composite
Index dropped 96.66, or 3.9 percent, to 2407.86.
Chinese stocks trading on U.S. exchanges also suffered losses on Tuesday. For
example, China Mobile ADRs (American Depository Receipts) fell 10 percent to
$44.16 in New York. China Mobile is the world's largest mobile-phone operator
by users. ADRs of China Life Insurance Co., the country's biggest life insurer, fell
8.8 percent to $38.48.
The FTSEurofirst 300 index of leading European shares closed 2.86 percent
lower at 1,506.05, the lowest since Jan. 11, erasing nearly two thirds of its gains
since the start of 2007. Australia's S&P/ASX 200 Index, which closed at a record
on Feb. 26, slumped 3.3 percent to 5797.90, while New Zealand's NZX 50 Index,
which reached a high on Feb. 7, tumbled 2.9 percent to 3980.14. Singapore's
Straits Times Index plunged 5.3 percent while Malaysia's Kuala Lumpur
composite Index tumbled 8.1 percent. Japan's Nikkei 225 Stock Average
slumped 3.9 percent.
The selling in European and U.S. equities was exacerbated by U.S. government
data showing a 7.8 percent drop in orders of durable goods. Non-defense goods
orders had their biggest monthly drop on record.
RISK ADVOIDANCE MOVES
On top of the sharp fall in Chinese stocks, worries about rising defaults among
high-risk borrowers in U.S. sub-prime mortgages led investors to sell risky
emerging market assets. Instead, they sought safety in government debt and
currencies with a low yield, such as the yen and Swiss franc.
"What we are seeing here is a reduction in the risk-seeking behavior of investors,
obviously globally if you look at international markets, and that usually brings
people back to what they perceive as the lowest risk market. And that is U.S.
Treasuries," said Jerry Webman, senior investment officer and chief economist,
Oppenheimer Funds in New York.
The yen rose 2.3 percent to 117.93 against the dollar at 4:15 p.m. in New York,
from 120.66 yesterday. The yen rallied explosively against the Australian dollar,
New Zealand dollar and Canadian dollar, all popular targets of carry trades.
The Swiss franc, another favored funding currency for carry trades that have
been used to finance purchases of everything from high-yielding currencies to
emerging market stocks, also rose sharply across the board.
The Australian and New Zealand dollars plunged the most in nine months
against the yen as investors reduced carry trades, selling high-yielding assets
funded with money borrowed in Japan.
``The Chinese stock market volatility has reverberated around the world and
there's been a round of yen safe-haven buying,'' said Peter Pontikis, treasury
strategist at Suncorp- Metway Ltd. in Brisbane, Australia. ``We had a pro-yen
and anti- carry trade movement.''
The Australian dollar fell 2 percent to 92.79 yen at 10:48 a.m. in Sydney from
94.67 yen late in Asia yesterday, the biggest decline since May, reaching a
seven-week low of 92.63 yen. It bought 78.59 U.S. cents compared with 79.32
New Zealand's dollar tumbled 2.2 percent to 82.41 yen at 12:47 p.m. in
Wellington from 84.25 yen in late Asian trading yesterday, also the largest
decline since May. It bought 69.76 cents compared with 70.58 cents yesterday.
On the other hand, Brazil's real, Turkey's lira and the South African rand led a
slump in developing-nation currencies. Brazil's real fell 1.8 percent to 2.1197 per
dollar from 2.0825 reals per dollar the day before. Turkey's lira sank 1.8 percent
to 1.4097 per dollar and the South African rand dropped 2.2 percent to 7.2337
Many jumpy investors fled to U.S. Treasury debt, sending the benchmark 10-year
yield -- which moves inversely to its price -- to its lowest level in 2007.
The yield on the benchmark 10-year note fell more than 11 basis points, or 0.11
percentage point, to 4.51 percent, according to New York-based bond broker
Cantor Fitzgerald LP. It was the biggest drop since Dec. 3, 2004, when
employment growth slowed. The yield touched 4.4485 percent, the lowest since
Dec. 6, 2006.
Emerging market sovereign debt spreads, also a gauge of global risk-taking,
surged 17 basis points, rising to as high as 189 basis points over benchmark
U.S. government yields on Tuesday -- 12 basis points wider than on Monday. A
basis point is 0.01 percentage point. That meant investors essentially were
demanding a bigger premium to hold emerging market debt.
MARKET OPENINGS WEDNESDAY IN ASIA
According to Shane Oliver, who helps manage about $64 billion at AMP Ltd. in
Sydney ``[China’s meltdown] will [continue to] reverberate in Asian markets [on
Wednesday].” Oliver noted that ``China's market has been poised for a
correction for some time, [and that this] has made other Asian markets
Wednesday morning in Asia, Asian stocks fell extending the global sell-off which
began the day before. Benchmark indexes in Australia and New Zealand, Asia's
first markets to open, fell. After four hours of trading New Zealand was down 2%
and Australia, after three hours, was down, 2.4%
In Japan, after two hours in early morning trade the Nikkei 225 had lost 3.6%.
Throughout Asia early morning trade, with the exception of the Taiwan exchange,
all exchanges were down.
China's stocks swung between gains and losses in early trading. The Shanghai
and Shenzhen 300 Index, which tracks yuan-denominated A shares listed on
China's two exchanges, had lost 38.85, or 1.6 percent, to 2418.64 as of 9:47 a.m.
local time. However, it earlier rose as much as 1.2 percent.
In the currency markets, the yen fell to 118.43 per dollar at 11:30 a.m. in Tokyo
from 117.93 late in New York yesterday, when it surged 2.3 percent. The reason
for the yen’s tumble was a government report which showed an unexpected drop
in Japanese industrial production and retail sales. The foreign exchange markets
sense that the data may prompt the Bank of Japan to leave its benchmark
interest rate at 0.5 percent, the lowest in the industrialized world. Factory output
in January fell a seasonally adjusted 1.5 percent from a record the previous
month and Japan's retail sales slid 0.8 percent from a year earlier.
Other Asian currencies including the Indonesian rupiah and Philippine peso
weakened in early trading in Asia.
MARKET CLOSINGS WEDNESDAY IN ASIA
By the close Wednesday in Asia, the Shanghai and Shenzhen 300 closed higher
after the Shanghai Securities News report and after the Oriental Morning Post
said China may allow qualified foreign investors to buy as much as $120 billion of
domestic equities, an equivalent to 10 percent the value of China's stock market.
In a statement released on Wednesday, Zhu Jian, the Shanghai-based director
of the China Securities Regulatory Commission said that China's share price
slump Tuesday was a ``normal correction,'' and the government has no plans to
buoy the stock market. In addition, the Shanghai Securities News reported on
Wednesday, citing officials at the finance ministry and tax bureau. That the
government wouldn’t impose a capital gains tax on stock investment,
Other Asian markets, however, continued their two day slide. Japan’s Nikkei 225
Stock Average tumbled 515.80, or 2.9 percent, to 17,604.12. The broader
Japanese index, the Topix index fell 58.59, or 3.2 percent, to 1752.74. Both
Japanese benchmarks had the biggest drop since June 13, 2006.
Japanese stocks also slid after the yen rose 2.3 percent to 117.94 against the
dollar in New York yesterday, the biggest jump in more than 19 months.
Investors were concerned about a strong yen’s negative impact on overseas
sales. Sony, the world's largest maker of computer game consoles, fell 350, or
5.4 percent, to 6,170 yen. Nomura, the nation's largest brokerage, plunged 145
yen, or 5.3 percent, to 2,575. Nippon Steel Corp., the world's second-biggest
maker of the alloy, dropped 31 yen, or 3.7 percent, to 805 yen.
``Japan is exporting more and more to China,'' Mark Mobius, who oversees $30
billion in emerging-market equities at Templeton Asset Management Ltd., said
from the Bahamas. ``Any downtrend in the Chinese market and people may think
that it would affect imports.'' China, including Hong Kong, is Japan's largest
trading partner and its second-biggest export market after the U.S.
The Hong Kong's Hang Seng Index, which tracks 37 mainland companies, and
which lost 2.5 percent on Tuesday, fell an additional 3.2 percent on Wednesday.
The Philippines' key stock index tumbled 7.9 percent, the biggest decline in the
region and the most in nine years. India's Sensitive Index slide 4 percent. All
other markets fell. Taiwan was closed.
The Morgan Stanley Capital International Asia-Pacific Index fell 3.1 percent to
144.15 at 7:41 p.m. in Tokyo. A 3.1 percent decline in the MSCI's Asia-Pacific
index is the equivalent of $239 billion of the 1,068-member measure's market
capitalization, according to Bloomberg data. The benchmark was worth $8.24
trillion at the end of trading on Tuesday.
The yen remained weak during Wednesday and by mid day in London was
trading at 118.50. Overall, the yen fell against 14 of the 16 most-active
currencies. Yen concern focused on recent weak industrial production and
slumping retail sales figures.
In addition, a technical chart some investors use to gauge currency movements
suggested the yen would pare its gains. The yen's 7-day relative strength index
versus the dollar fell to 26.6 yesterday, from 49.5. A reading below 30 or above
70 may indicate a currency will reverse course.
Asian currencies including the Indonesian rupiah and Philippine peso weakened
today as fund managers pared riskier investments following a slump in emerging-
market equities that continued from yesterday. The rupiah slid 0.8 percent to
9,153 per dollar and the peso fell 0.3 percent to 48.55.
MARKETS IN EUROPE AND AMERICA ON WEDNESDAY
In early trading in Europe, the sell off in stocks continued. By 12:20 pm in
London, the Dow Jones Stoxx 600 Index had lost 1.2 percent to 366.14. The
Stoxx 600 Index fell 3 percent on Tuesday, the biggest decline since May 2003.
The benchmark FTSE 100 Index lost 72.2, or 1.2 percent, to 6,213.70 by 12:23
p.m. in London. The FTSE All-Share Index retreated 37.73, or 1.2 percent, to
3214.59. Ireland's ISEQ Index slid 130.54, or 1.4 percent, to 9405.69.
By noon in London, national benchmarks had slid in all 18 western European
markets. France's CAC 40 was down 0.8 percent as was the U.K.'s FTSE 100.
Germany's DAX had fallen 0.9 percent.
``It's not pretty,'' said Andrew Popper, chief investment officer at SG Hambros in
London, who helps manage the equivalent of $13.7 billion. ``[However], we were
due a correction.''
In early trading in the United States, U.S. stocks rose a day after their biggest
plunge in four years. As of 9:42 a.m. in New York, the Standard & Poor's 500
Index gained 7.41, or 0.5 percent, to 1406.45. The Dow Jones Industrial Average
increased 52.23, or 0.4 percent, to 12,268.47. For both benchmarks, it was the
first advance in six days. The Nasdaq Composite Index rose 3.21, or 0.1 percent,
to 2411.07. Before yesterday's tumble, the S&P 500 had gained 2.2 percent for
the year, building on four years of advances. The S&P 500 and Nasdaq last
week closed at six-year highs, while the Dow set a record. All three benchmarks
are now down in 2007.
``Following a long, correction-free rally in equity markets, the move appears more
technical than fundamental,'' wrote Darren Read and Larry Hatheway of UBS's
global asset allocation team in a report distributed today. ``We use this
opportunity to add to our equity overweight.''
Federal Reserve Chairman Ben Bernanke told Congress on Wednesday that the
administration and federal regulators are closely monitoring financial markets in
the wake of the biggest sell-off in stock prices in more than five years but so far
the markets appear to be "working well." Testifying before the House Budget
Committee, Bernanke also said there had been no major change in the outlook
for the economy, reiterating that the Fed expects "moderate growth" this year.
By the late morning in New York, the markets were still up. As of 11:24 a.m., the
Dow average added 99.42, or 0.8 percent, to 12,315.66 The Standard & Poor's
500 Index rallied 13.36, or 1 percent, to 1412.40. All 24 industry groups in the
benchmark rose. The Nasdaq Composite Index increased 16.65, or 0.7 percent,
to 2424.51. On the New York Stock Exchange, more than two stocks had
advanced for every one that fell. Some 873 million shares changed hands on the
Big Board, 85 percent more than the same time a week ago.
However, in afternoon trading in Europe, stock continued to move down.
Emerging markets slumped, with stocks falling in India, Russia and Turkey.
By the close in Europe, European stocks experienced their biggest two- day drop
in 4 1/2 years, extending a slump that wiped more than $1 trillion off the value of
global equities. The Dow Jones Stoxx 600 Index lost 1.5 percent to 365.05 at the
close in London after earlier dropping as much as 2.2 percent. The measure had
the biggest two-day loss since 2002. National benchmarks slid in all 18 western
European markets. France's CAC 40 declined 1.3 percent. The U.K.'s FTSE 100
lost 1.8 percent while Germany's DAX slipped 1.5 percent. The measure earlier
fell as much as 2.6 percent.
``This type of correction is very healthy,'' said Andreas Utermann, who oversees
$1.5 trillion as the London-based global chief investment officer at AllianzGI.
``Once we see signs of stabilization, it will be a great buying opportunity.''
``Sentiment appears to be the main driver of the market at the moment,'' said Ed
Wallace, who helps manage $2 billion in global equities at Gartmore Investment
Management in London. ``Little has changed with economic fundamentals.''
European government bonds were higher, as investors bought into the safety of
bonds in the face of nervous equity markets. According to David Brown at Bear
Stearns "European bond markets have enjoyed a fresh lease of life in recent
sessions with increased global contagion jitters suddenly exciting resurgence in
flight-to-quality and safe haven bids." Brown also said, however, that markets will
come back to look to fundamentals for direction once the dust has settled.
Emerging-market bonds also rose, rebounding from their fall yesterday. Bond
investors said the rally in commodity prices will keep propelling growth in
According to JPMorgan Chase & Co.'s EMBI Plus index, emerging-market bond
yield spreads today narrowed 12 basis points, the biggest drop since Feb. 10,
2006, to 1.81 percentage points, after surging 21 basis points yesterday,. The
spread is now 17 basis points above the record low of 1.64 points on Feb. 22.
Silvia Marengo, who manages $130 million of emerging-market bonds at
Clariden Bank in London noted that ``There's a bit of a recovery [in emerging
bonds]'' and that ``The fundamentals are the same in that emerging markets is a
commodity story.'' Argentine and Venezuelan bonds, two of the biggest decliners
yesterday, lead today's rebound. Crude oil, the biggest export of developing
economies such as Ecuador, Venezuela, Mexico and Nigeria, remains above
$60 a barrel.
In European currency markets, after showing strength yesterday, both the yen
and the Swiss franc dropped by the close on Wednesday, suggesting investors
are returning to the so-called carry trade. Against the dollar, the franc was at
1.2220 by 5:00 p.m. in Zurich, from 1.2175 late yesterday. That's the biggest
drop since Feb. 12. The yen also dropped from a seven-week high to 118.69
versus the dollar as of 4:00 p.m. in London, from 117.93 late yesterday in New
According to Mitul Kotecha, head of global foreign-exchange strategy at Calyon
in London,``the environment remains positive for continued investment in carry
trades in the months ahead and it may be a while before such trades are
significantly scaled back,'' This ``is reflected in extreme levels of speculative
positioning in currencies such as the yen and the Swiss franc.''
Low borrowing costs make the franc and yen favorites for speculators.
Switzerland's 2 percent benchmark interest rate and Japan's 0.5 percent
benchmark compares with 3.5 percent in the euro region and 5.25 percent in the
In addition, foreign exchange intervention to support either the franc nor the does
not seem likely. Japan stopped intervening in 2004 and Swiss National Bank
officials, most recently its President Jean-Pierre Roth, have said the bank won't
buy the franc to stem its decline.
By the early afternoon in New York, stocks were still higher. As of 1:24 p.m. in
New York, the Dow average had added 74.50 on the day, or 0.6 percent, to
12,290.74. The Standard & Poor's 500 Index rallied by 9.59, or 0.7 percent, to
1408.63. All 10 industry groups in the benchmark rose. The Nasdaq Composite
Index had increased 13.81, or 0.6 percent, to 2421.67.
At the close in New York, the Dow industrials finished up 52.39, or 0.4 percent, to
12,268.63. The Standard & Poor's 500 Index closed up 7.78, or 0.6 percent, to
1406.82. The Nasdaq Composite Index increased 8.29, or 0.3 percent, to
2416.15. On the New York Stock Exchange, seven stocks rose for every five that
fell. Some 2.26 billion shares changed hands on the Big Board, 47 percent more
than the three-month daily average.
Consumer, telephone and health-care shares led the advance as investors
sought companies with earnings less reliant on swings in the economy. Procter &
Gamble Co. climbed the most in seven months for the best performance in the
Dow Jones Industrial Average.
ADDITIONAL CHINA BACKGROUND
China's government has introduced several measures over the past year to calm
the stock market. Banks were urged to stop lending money for stock investments
and to recall outstanding loans, the China Banking Regulatory Commission said
Dec. 31. The People's Bank of China, the central bank, ordered banks to boost
reserves four times in the past year to reduce money available for investment.