Liam Dann: Here's what's happening on world markets

Trader Gregory Rowe works on the floor of the New York Stock Exchange. Photo / AP

Panic and fear are taking hold in global markets with Wall Street now at risk of slipping into Bear territory (meaning stocks have slipped 20 per cent from a recent peak). This has sent shock waves around the world and sparked fears that we may be facing a new global financial crisis.

There are some good reasons why we shouldn't be panicking just yet. But the falls this morning have been extreme, with oil dropping seven per cent to its slowest point since 2003 and US markets at one stage falling about three per cent before recovering slightly.

Why are markets crashing?

The China slowdown and oil prices are the big drivers of the panic. Supply and demand for oil have been out of whack for 18 months now. That's longer than most experts predicted and this latest slump represents a fresh global shock.
Throw in ongoing negativity about the Chinese economy, which brings concerns about global deflation, and you have yourself a reasonable excuse for a sell off.

None of these things are particularly new issues though which begs the question:

Why now?

The US market was looking for an excuse. Commentators have been calling US markets overvalued for several months and some sort of correction was overdue. With US interest rates at near zero levels investors have been increasingly looking to Wall Street for returns.

The appetite for risk has grown and grown to a point where the valuations of many stocks - especially fast growth tech stocks - are now far removed from fundamental earnings. This position is never sustainable.

When the gap gets too wide it becomes a case of "when" not "if" markets will fall. And when it does come, the exact trigger for the fall - be it China, oil prices or butterfly flapping it wings in Timbuktu - is secondary to the fact the market was ready to sell.

Unfortunately market behaviour seldom involves a gentle, orderly readjustment.

Will this lead to a global recession?

No, it shouldn't. At least not unless we see things get a lot worse in China. The global financial crisis in 2008 caused big problems because the crash was deeply linked to the US housing market. In other words it bore a direct correlation to the real world. The overall direction of the US economy is still positive - its just slow and Wall Street has gotten too far ahead of it.

The big deflationary risk stalking the world isn't going away but is a more insidious beast than a market slump. It is a slow moving economic phenomenon and its effects are more likely to play out over months and years.

What's wrong with cheap oil anyway?

The latest slump in oil price is also as much a supply side issue - as global sanctions against Iran are lifted - as it is a demand issue. It will keep oil lower longer but doesn't change the dynamic.

Amidst the gloom it is also worth remembering that cheaper oil is as good as tax break or lower interest rates for businesses and consumers. And if inflation stays in hiding we might even get another interest rate cut too.

How serious is this for New Zealand?

I'm not convinced the market correction is a big deal for New Zealand yet. This isn't great news for share market investors and if you have a KiwiSaver account that means you. But New Zealand stocks are off just 4.3 per cent from a record high on December 31.

They came back strongly from the Chinese market crash in the middle of last year and there is no reason to assume they won't rebound again once this one plays through.

New Zealand markets are always going to follow global trends to some extent. We're particularly closely tied to Australia which will have issues with energy and mineral stocks. But the fundamentals for most NZX listed companies aren't directly tied to commodities. General business confidence is a bigger concern. That was on the up in the last quarter of 2015. Let's hope it is not too seriously rattled by this latest global panic attack.

What happens next?

Most likely we'll see the sell-off run on for a few more days and then a period of volatility as stocks bump there way back to a new base level.

Then, with any luck, we'll see the US economy resume its snails pace recovery. It might be painfully slow but as the US strengthens it adds lot of momentum to the global.

That growth - as forecast by the IMF this week - may be lower this year than had been hoped. We have every reason to expect that China will keep slowing and New Zealand's biggest risk is probably that dairy prices stay down longer than hoped.

This could mean slower growth. But the economy is in fundamentally good shape with both the Government and Central Bank well positioned to stimulate things further if needed.