'The Price of Oil, China, and Stock Market Herding'

Olivier Blanchard:

The Price of Oil, China, and Stock Market Herding: The stock market movements of the last two weeks are puzzling.

Take the China explanation. A collapse of growth in China would indeed be a world changing event. But there is just no evidence of such a collapse. ...

Take the oil price explanation. It is even more puzzling. Traditionally, it was taken for granted that a decrease in the price of oil was good news for oil importing countries such as the United States. ... We learned in the last year that, in the short run, the adverse effect on investment on energy producing firms could come quickly and temporarily slow down the effect, but this surely does not undo the general conclusion. Yet the headlines are now about low oil prices leading to low stock prices. ...

Maybe we should not believe the market commentaries. Maybe it was neither oil nor China. Maybe what we are seeing is a delayed reaction to the slowdown in the world economy... Maybe…

I think the explanation is largely elsewhere. I believe that to a large extent, herding is at play. If other investors sell, it must be because they know something you do not know. Thus, you should sell, and you do, and so down go stock prices. Why now? Perhaps because we have entered a period of higher uncertainty. ...

So how much should we worry? This is where economics ... gives the dreaded two-handed answer. If it becomes clear within a few days or a few weeks that fundamentals are in fact not so bad, stock prices will recover... If, however, the stock market slump lasts longer or gets worse, it can become self-fulfilling. Low stock prices lasting for long lead to lower consumption, lower demand, and, potentially, to a recession. The ability of the Fed, fresh out of the zero lower bound, to counteract a slowdown in demand remains limited. One has to hope for the first scenario, but worry about the second.