The falls in the global stock markets: The start of a recession or repairing a wrong?

“Only when the tide goes out do you discover who’s been swimming naked.” — Warren Buffet

2016 started with a sharp downturn in world markets, and for many portfolio owners, and managers, it would be gratifying just to return to where we started off.

Will the market will correct itself, or will it continue in its decline? To try to analyze whether the market will continue to fall, we have to solve the mystery of whether we are on the verge of an economic or financial crisis.

Two of the properties which previously existed on the eve of financial crises do not exist today.

Firstly, the interest rates. Towards the crises in 2008 and 2001 US interest rate was around 5%. We are not in that position today, and, even if the Fed will raise interest rates once or twice more this year the rates are far from the levels pre 2001 and 2008 financial crunches. Today, investors do not have the privilege to flee the equity markets to higher interest rates in the market bond.

Secondly, there is no world recession. China’s growth is lower than expectations and probably has not grown 6.9%, as according to official figures. Previous crises were accompanied by recessions in the world. True, today there are economists who argue that the US will slip into recession in 2017, however, the vital signs of the US economy are still positive.

Causing further instability are the Chinese efforts to stabilize the situation. The Chinese are doing this by way of government intervention. Although the intentions are good, markets in general respond negatively to the notion the governments can intervene with market forces, especially in the aggressive way that the Chinese government intervenes.

However, even if we are not on the verge of an economic or a financial crisis, there are signs which hint to vulnerability in the markets. It always comes from the same place – leverage. For the past seven years, companies have generously leveraged at very reasonable prices, have developed their business and cared for their shareholders through generous dividends and buy-back. Now, when there is heavy pressure on the revenue line of those companies and lower global growth, companies will have to work primarily to serve the creditors. This is the main reason why some overpriced stocks will take a dent in the metalwork.

There will be cases of insolvency and lack of cash flow to service the debt, raising the prospects for an increase in bankruptcies. The most obvious examples of this are the world’s metals companies. These companies are borrowing in bonds to develop more mines, when they thought that demand for metals from China will only increase. In reality, China requires less raw materials, after years of rapid industrialization, and there is no country in the world which is replacing China in demanding these products. The result is that metals prices crash and revenues go down sharply. The combination of these factors will conclude, inevitably, in companies that will not be able to serve their debt.

Another industry which will cause the market to continue to be volatile is the energy market. Morgan Stanley has said oil could fall to $20 a barrel, while Standard Chartered has predicted an even bigger slide, to as low as $10. Standard said: “Given that no fundamental relationship is currently driving the oil market towards any equilibrium, prices are being moved almost entirely by financial flows caused by fluctuations in other asset prices, including the US dollar and equity markets.

The Israeli share market should stand out with relatively moderate declines. 30% of our index is in global pharmaceutical, which is a defensive industry in terms of risk and leverage. The corporate leverage in Israel is lower than most western countries and the currency remains stable.

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The writer is founder of Western Wall Street