By Paul J. Lim
January 7, 2016
STR—AFP/Getty Images

Here we go again.

For the second time this week, concerns about the world’s second largest economy sent Chinese stocks plummeting more than 7%. And for the second time this week, Chinese regulators were forced to halt trading to stem the bleeding.

“These market reactions seemed to confirm that China’s economy is in serious trouble,” said Ed Yardeni, president and chief investment strategist at Yardeni Research. They also reverberated around the world.

European shares sank more than 3% on those global economic fears, and early this morning, the Dow Jones industrial average fell more than 220 points at the open — after slipping more than 252 points on Wednesday and 276 points on Monday.

Less than a week into the new year, the Dow is already down more than 3.5%, marking the worst start to a year for stocks since the global financial panic of 2008. And since last February, the benchmark index of U.S. stocks has fallen 11%, raising questions about whether this bull market will survive to see its seventh birthday on March 9.

But before investors assume the worst, there are a few important things to keep in mind:

1) The same chain of events occurred last summer — and stocks survived.
From last July to August, the Dow sank 11% in reaction to the 30% decline in the Shanghai composite index, which again was rooted in fears that the world’s second largest economy was slowing down. Yet Chinese stocks rebounded more than 19% for the remainder of the year while U.S. stocks climbed 7%.

The bulls note that there are scant signs of a potential recession lurking in the U.S. economy. And that’s good news. Historically, the vast majority of U.S. bear markets foreshadowed a recession. Moreover, the handful of bear markets that didn’t precede a recession turned out to be relatively mild.

2) Oil prices that have contributed to the sell-off can contribute to a rebound.
At the same time that China’s stocks have been selling off, crude oil prices have kept tumbling, reinforcing the notion that the global economy is in trouble.

But plummeting oil prices—crude oil has slumped more than 40% since last May, to just $36 a barrel—have as much to do with a supply glut as they do with weakening demand for energy.

And given that the global economy is still growing, it’s hard to imagine that prices can remain this low for the foreseeable future. “Prices have now declined to the point where they are below where we think the equilibrium level is,” said Brian Singer, head of the dynamic asset allocation strategies team at William Blair. “As we dip below $40, there might be more downside, but it’s probably run its course.”

3) China’s sell-off may have as much to do with policy as the economy.
The setback in Chinese stocks not only reflects worries about the economy, but also a lack of confidence in the government’s economic and regulatory policies, said Bill Witherell, chief global economist at Cumberland Advisers.

For instance, Brian Jackson, China economist for IHS Global Insight, notes that “regulators imposed new limits on share sales in China’s stock markets on Thursday following an automatic freeze in trading, prompting widespread complaint from local traders at market interference and policy uncertainty.”

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