Billions in Losses as Stock Markets Collapse: Why Is Fear Sweeping Global Markets?

Global stock markets are experiencing a sharp decline, the largest since the COVID-19 pandemic, with the American stock market suffering alarming losses. Markets have turned red, with most American stock indices falling, and declines in the dollar and oil indices, while gold futures show some recovery.

Data reveals that the unemployment rate in the United States surged to its highest level in three years at 4.3% in July, amid a significant slowdown in hiring. This has heightened fears of a deteriorating job market and a possible economic recession. So, what is happening, and why is fear engulfing global markets?

Why Is Fear Dominating Markets Everywhere?

According to The Economist magazine, just two weeks ago, stock markets were on an unstoppable upward trajectory, following months of new record highs. Now, they are in freefall. The Nasdaq, dominated by tech giants that were at the heart of the boom, has dropped more than 10% since its peak in mid-July.

The S&P 500 and Dow Jones indices have fallen by 6% and 4% respectively from their all-time highs. The Japanese Topix index recorded losses exceeding 10%, with a 6% drop on August 2—the worst day since 2016—following a 3% decline on August 1, marking the worst two days since 2011. While stock prices elsewhere haven’t been hit as hard, panic is sweeping through global markets.

The Wall Street Fear Index, which measures expected volatility through the prices traders pay for protection, has risen to its highest level since last year’s regional banking crisis in the U.S.

Beneath the surface, individual sectors and companies reflect even greater turmoil. The Philadelphia Semiconductor Index, tracking global chip supply chain companies, has dropped more than 20% in weeks. ARM, one of these companies, lost 40% of its market value. Nvidia’s stock, once a favorite during the boom, fluctuated wildly—falling 7% over three days starting July 30, then rising 13%, and falling 7% again.

On August 2, Intel, another chipmaker, saw its value drop by over a quarter. It’s not just the semiconductor industry; the KBW Bank Index for U.S. bank stocks fell 8% in days, and Japanese bank stocks have also now dropped.

Semiconductor Industry and AI Investment Decline

Safe havens like gold and U.S. Treasury bonds, typically sought by investors during fear-driven times, are also under pressure. On August 2, gold prices dropped more than 2% from their peak to the bottom. Gold is usually a hedge against the very chaos currently unfolding.

The drop in gold prices suggests that investors might be selling not out of choice but out of necessity to raise cash quickly to meet margin calls elsewhere. If this is the case, there’s a risk of further rapid sales and a self-reinforcing downward spiral.

The Economist highlights three developments pushing investors to the brink. First, there is the realization that artificial intelligence, particularly the semiconductor industry supporting it, has been overly inflated with unrealistic hopes.

The biggest fluctuations in U.S. stock prices occurred over ten days as five tech giants—Alphabet, Amazon, Apple, Meta, and Microsoft—reported results that left shareholders frustrated. Even Alphabet and Microsoft, which exceeded analysts’ revenue forecasts, saw their stock prices fall the day after their announcements.

Amazon’s shares, which didn’t meet such forecasts, faced even harsher punishment. The broad disruption indicates that the previous investor euphoria over AI is evaporating, which directly impacts chip manufacturers who may not see unlimited demand for their products if AI investment slows.

Recent weeks have also brought significant changes. On July 17, former President Donald Trump triggered a semiconductor market crash by suggesting Taiwan should pay for its defense against China.

Taiwanese company TSMC, which produces the majority of the world’s advanced chips, is based in Taiwan and thus vulnerable to potential Chinese invasion. The Biden administration is also planning to impose new restrictions on chip manufacturing equipment exports to China.

U.S. Unemployment Report

With dual threats of faltering demand and worsening geopolitical issues, it’s no surprise that semiconductor stocks are plunging. As tech companies falter, the U.S. economy is also struggling, which is the second factor.

Recently, the market motto was “bad news is good news.” Any hint of slower growth or a weak job market was beneficial for asset prices as it suggested that inflation would likely remain subdued, allowing the Federal Reserve to cut interest rates faster.

However, by the time the U.S. jobs report was released on August 2, the mood had worsened: bad news was now bad news.

The report revealed that the unemployment rate rose to a three-year high of 4.3% in July, while the economy added only 114,000 jobs, against a prior consensus expectation of 175,000. In other words, the risk of a recession that many thought had been avoided has just increased. Consequently, traders began betting that the Federal Reserve would cut interest rates by half a percentage point at its next meeting in September to avoid such a slowdown.

This is despite Federal Reserve Chairman Jerome Powell’s rejection of suggestions that rate setters were considering such a move at the recent meeting just days before.

Treasury yields have fallen, with the two-year interest rate dropping to 3.9%, more than a percentage point lower than its level at the end of April. Weeks ago, such a reduction in borrowing costs might have boosted stocks. Now, investors seem more concerned about the downside risks of slower growth and its impact on corporate earnings than about the prospect of cheaper money.

Rapid Rise in Japanese Yen Value

The Economist notes that a third factor driving markets is the strength of the Japanese yen. In recent weeks, the yen has strengthened against a basket of trade-weighted currencies, at its fastest pace in two decades. This is partly due to the Bank of Japan’s surprising decision to raise interest rates by 0.1% on July 31.

A rising yen automatically lowers Japanese stock prices, as many of Japan’s largest companies, such as Hitachi, Sony, and Toyota, earn their profits abroad in foreign currencies. This might explain some of the recent decline in Japanese stocks. However, more importantly, it likely reflects the unwinding of popular trades tied to a weak yen and extremely loose monetary policy.

The combination of cheap yen borrowing, converting returns into dollars, and investing in Treasury bonds—which yields much higher returns than the cost of debt—has been known as the “carry trade.” But with rising Japanese interest rates and falling U.S. rates, the appeal of this trade is fading.

Worse, the rapid appreciation of the yen increases the cost of servicing dollar-denominated debt, causing trade to decline. The violent moves in recent weeks have forced many investors to close their positions and possibly sell other assets at depressed prices, adding to instability in both domestic and global stocks.

As always at the end of a tumultuous week, the key question is whether the price of an asset has swung sharply enough to endanger an institution heavily exposed to this volatility. On this front, the drop in gold prices and bank stocks is ominous.

The other question is whether the coming week will be better or worse. If major investors decide that it’s time for massive sell-offs, it could improve the collective mood. Based on the current situation, this doesn’t seem promising.

Oil Prices Decline

Oil prices fell on Friday’s session, closing at their lowest levels since January, following data showing U.S. job growth slowed more than expected last month, compounded by Chinese economic data adding pressure on prices.

Brent crude futures fell by $2.71, or 3.41%, to $76.81 per barrel at settlement, marking a weekly decline of 4.3%, its fourth consecutive weekly loss. U.S. West Texas Intermediate crude futures dropped by $2.79, or 3.66%, to $73.52, recording a 4.7% weekly loss.