U.S. and European stocks soared Tuesday after China's central bank cut interest rates and reduced required bank reserves at the close of another cold bath for the Shanghai Composite, which fell 7.6 percent to close below the 3,000 level, the lowest level in nine months. That plunge followed a drop of 8.5 percent on what Chinese analysts are calling "Black Monday," the worst plunge in eight years and the 10th drop of more than five percent in the past year. In the past four days, the Shanghai Composite has lost 22 percent of its value. China's other markets also fell sharply on Tuesday, as did the Japanese Nikkei, which had opened with considerable upward strength.
Meanwhile, following the worst three-day point drop in Dow history, U.S. stocks gained sharply Tuesday. At 11:30 AM ET, the Dow was trading up 2.6 percent at 16275, up more than 400 points over Monday. That was still nearly 200 points below the open on Monday and 11 percent lower than the all-time market peak of 18351 reached in May. The London, German, French and pan-European markets also made major gains in the 3-5 percent range.
Although the crash in China's markets has been spectacular, it's important to note that the amount of wealth held in the stock market there is relatively small, most of it being in property instead. Although many Chinese citizens have recently bought stocks for the first time, propelled by the government's decision to allow them to do so on borrowed money, and they are surely hurting from the plunge, this still represents a small part of their nation's economy.
The cause for the huge drop the past few days was the devaluation of the yuan on August 11, the release of information Friday showing that China's industrial activity has been slowing greatly, and the failure of Beijing to come up with any interventions to steady equity values.
Head below the fold for more on this story.
2:47 PM PT: The Dow Jones industrial average and the S&P 500 closed about 1.3 percent lower after rallying nearly 3 percent earlier. It was their biggest reversal to the downside since Oct. 29, 2008. The Dow also posted its first six-day losing streak since July 2012.
Several analysts called what happened on Monday in Europe and the U.S. an overreaction to the plummet in China's markets. Despite the latest intervention by Beijing, there could still be more to come in the battering those markets have taken. At CNBC, See Kit Tang reported:
According to IG's market strategist Bernard Aw, there is no easy explanation for the meltdown in the mainland markets, which indicates that significant downside risks remain.
"Some blamed it on the yuan devaluation and the Chinese [factory activity] readings. Some said the broader conditions of slowing global growth, falling commodity prices and deflation risks dragged equities down. They could all be right," Aw wrote in a note issued late Thursday. "But I feel that the lack of clarity on what was the trigger for the stock slump makes it difficult to get a sense of the market—this suggests that the selloff could still have some room to go."
What the market's reactions will do to the Fed's plans to raise interest rates this year for the first time in more than nine years remains a matter of speculation. At the
New York Times, Binyamin Appelbaum
reported that some investors' speculation the Fed might hold off until 2016 before raising rates was premature:
“The current bout of market turmoil, if it continues, might persuade the Fed to hold off on raising interest rates in September,” Paul Ashworth, chief North America economist at Capital Economics, wrote on Monday. “Since that volatility doesn’t reflect any genuine economic slump, however, we wouldn’t be surprised if it proved short-lived, leaving the way open for the Fed to begin raising rates at some point this year.”
Janet L. Yellen, the Federal Reserve chairwoman, has said that the Fed wants to raise its benchmark rate slowly over the next several years, gradually reducing its long-running stimulus campaign to bring the economy back to good health. The Fed has held short-term rates near zero since December 2008.