Three reasons Taiwan’s stock market plunge is a warning to the world

The sell-off in Taiwan is a microcosm of the challenges confronting investors everywhere
A sudden surge in coronavirus cases, high levels of margin debt and the vulnerability of technology stocks are factors that resonate beyond the island

Nicholas Spiro

Published: 2:30pm, 20 May 2021

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For the resoundingly bullish investors and traders whose bets on the direction of markets have paid off handsomely since the Covid-19 pandemic erupted in March last year, the recent plunge in Taiwan’s stock market is just a blip.

While the Taiex, Taiwan’s benchmark gauge, fell 8.4 per cent last week, it rebounded 5.1 per cent on Tuesday, easing concerns about an equity market that was the world’s best performer in the past three years but is also now the most volatile among major gauges tracked by Bloomberg.

On the face of it, the tremors in Taiwan’s stock market are the latest example of the enduring resilience of asset prices to a succession of threats, the latest of which is the surge in inflation that is fanning fears about an earlier-than-expected withdrawal of monetary stimulus.

Yet, the heavy selling pressure in Taiwan, which came like a bolt from the blue, has exposed acute vulnerabilities in global markets. While these risks have been apparent for some time, and were the trigger for earlier sell-offs on Wall Street, they continue to chip away at sentiment.

Although the past year has shown the extent to which investors, heartened by unprecedented levels of stimulus, are willing to downplay all sorts of threats for fear of missing out on further gains in asset prices, the sell-off in Taiwan is a microcosm of the challenges confronting investors.

A soldier disinfects a person who is leaving a Covid-19 testing site following a surge of infections in Taipei, Taiwan, May 19, 2021. Photo: Reuters

First, the catalyst for last week’s rout was the unexpected surge in new Covid-19 cases. The fact that Taiwan, which was long seen as having one of the most effective containment strategies, is now suffering a dramatic increase in infections shows the degree to which the pandemic continues to bedevil the global economy and markets.

Indeed, the most troubling aspect of the sudden outbreak in Taiwan is the complacency that allowed the virus to spread. This was the main cause of India’s calamitous second wave, and one of the reasons the reopening process across Asia is proving more difficult than anticipated. Taiwan’s woes show how insufficient testing capacity and delays in rolling out mass vaccination programmes pose a significant threat to recovery.

Second, while the pandemic was the trigger, the sell-off was exacerbated by forced selling by highly leveraged retail investors who had taken on levels of margin debt – funds that investors borrow to increase their exposure – that far exceeded the rise in Taiwan’s stock prices. The disorderly unwinding of this leverage has accentuated the dangers of margin debt.

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The forced deleveraging in Taiwan pales in comparison to the damage caused by the collapse in March of Archegos Capital Management, an obscure US-based family office that was forced to sell its stakes in blue-chip stocks after being unable to pay margin calls. This saddled some of the world’s biggest banks with losses of US$10 billion.

With total margin debt across Wall Street having ballooned to nearly US$850 billion – more than double the peak just before the 2008 financial crisis – there is ample scope for more Archegos-type blow-ups given the increasing uncertainty in markets caused by the surge in inflation.

Third, Taiwan’s equity market is particularly vulnerable because of broader concerns about technology stocks, which make up almost 60 per cent of the Taiex, according to Bloomberg. The shares of tech companies, especially the least profitable ones, are under pressure because of fears of higher interest rates, a vaccine-induced shift in favour of other industries and the sector’s lofty valuations.

Some of the frothiest corners of the markets have already experienced dramatic falls in prices. On Wednesday, bitcoin, the perennially volatile cryptocurrency, tumbled a further 12 per cent due to persistent concerns about its potential as an asset class, taking its losses since mid-April to 40 per cent.

Other areas of speculative excess have also suffered over the past few months. Shares of special purpose acquisition companies (Spacs) – shell companies that raise money through public listings and use the proceeds to hunt for private companies to take public – have plummeted since their stock market debuts. Meanwhile, the Ark Innovation exchange traded fund, one of the most popular tech funds, is down 34 per cent since mid-February.

While inflation has become Wall Street’s bogeyman, deflation poses a bigger threat to asset prices, particularly those parts of the markets that are insanely overpriced. Even the Federal Reserve, which would never admit that there are bubbles, has sounded the alarm. Last month, Fed chair Jerome Powell said some areas of the markets “are a bit frothy, and that’s a fact”.

To be sure, sentiment remains unambiguously bullish, as the findings of Bank of America’s latest fund manager survey make clear. Taiwan’s stock market is too small to be systemically significant. Yet, the forces at play in last week’s sell-off are a warning shot for global markets that should not be dismissed.

Nicholas Spiro is a partner at Lauressa Advisory

This article appeared in the South China Morning Post print edition as: Pay attention to Taiwan, the canary in investors’ coal mine