It takes a 20% decline to enter “bear market” territory. So far, the Dow is 13.8% off its April 29 high. NASDAQ is 12.4% off its peak and the S&P 500 is down 14.7%. However, the MSCI ACWI (All Country World Index) entered bear market territory last week, falling 21% below its April 29 high.
Ironically, this sharp decline came at the same time that G-20 finance ministers and central bankers said they would take “all necessary action” to “maintain financial stability, restore confidence and support growth.” In essence, however, global financial markets have fully discounted a default by Greece. The market is preparing for the worst.
So the only remaining question, then, is how bad that loss will be. If Greece restructures its debt, a loss of about 21% is anticipated. However, if this debt restructuring fails, losses of 40% or more are likely. Overall, the International Monetary Fund estimates that European banks face $411 billion in potential losses.
IMF Managing Director Christine Lagarde told last week’s assembled G-20 finance ministers and central bankers that “the bad news is that there are downside risks on the horizon, and they are piling up.” She said the global economy is in “a negative feedback loop,” marred by “inefficient political commitment.” Earlier in the week, the IMF officially said the world economy had entered a “dangerous new phase.”
After Greece, the top priority in the euro zone now seems to be preventing Italy from defaulting. Since Italy is the third-largest sovereign debt market in the world, after the U.S. and Japan, European banks tend to be loaded with Italian debt, so as euro-bond yields rise, their capital erodes. S&P downgraded Italian sovereign debt to “A” last week with a “negative outlook” due to Italy’s fragile governmental coalition.
In my opinion, global financial markets grossly overreacted to Thursday’s preliminary report from HSBC (NYSE:HBC) that China’s Purchasing Managers Index fell to 49.4 in September, down from 49.9 in August. This single report formed the basis for the panic sale of most commodities. But HSBC’s chief China economist, Hongbin Qu, said that “fears of a hard landing are unwarranted.” HSBC said domestic demand in China remains “resilient” and should support Chinese GDP growth of between 8.5% and 9%.
Because of continued robust growth in emerging markets, the IMF still is expecting 4% global GDP growth in both 2011 and 2012. Economic growth is sputtering in the established economies, but not in the emerging markets. The IMF now expects the U.S. economy to grow 1.5% in 2011 and 1.8% in 2012, down from its June forecast of 2.5% in 2011 and 2.7% in 2012. In the euro zone, the IMF lowered its outlook to 1.6%.
Those numbers are low but still positive, and a 4% global growth figure should be a cause for celebration.
