Extreme fear is haunting markets again. Here’s why investors are running scared

Investors are really nervous right now.

CNN’s Fear and Greed Index, which tracks seven indicators of market sentiment in the United States, tipped into “extreme fear” Thursday for the first time since March, when a banking crisis was sowing panic among investors.

Today it is a painful mix of rising oil prices, expectations of “higher for longer” interest rates in the US and Europe, and a Chinese economy stuck in the doldrums that is stirring their fears.

Oh, and the US is yet again on the precipice of another government shutdown, an event that could result in a downgrade to its credit rating and lead to volatility in US stocks.

Michael Hewson, chief market analyst at stockbroker CMC Markets, told CNN that the US and Europe could “well be heading for a prolonged period of stagflation” where rates “are higher for longer” and economic growth slows to the point where “we could see a recession.”

Following a bruising 2022, stocks around the world have recovered most of their losses. The S&P 500 index (SPX) has risen 11% since the start of the year, the tech-heavy Nasdaq (NDX) 33%, and the Stoxx Europe 600 (STOXX) 5%.

But, in the past few weeks, cautious optimism has given way to worry. Since mid-September, stocks on the S&P 500 and the Nasdaq have dropped by 5% and 6% respectively. The Stoxx Europe 600 has fallen 3.3%.

‘Higher for longer’ interest rates

The world’s major central banks have spent the past two years hiking borrowing costs in a bid to control runaway inflation.

High interest rates typically put pressure on stocks, since investors tend to favor bonds when they offer comparable returns as they are safer. Elevated rates also mean companies can expect to pay more interest on their debt in the future, eating into future cash flows.

Earlier this month, hopes that falling inflation in the US could soon trigger a reversal of monetary policy were tempered by indications from the Federal Reserve that it could hike rates once more this year and expected to make fewer rate cuts in 2024.

Robust economic growth in the US has fueled concerns among Fed officials that inflation could surge again, meaning rates would need to stay higher for longer to cool demand.

Oil is approaching $100 a barrel

Extra support for that outlook has come from soaring oil prices.

Brent crude oil, the global benchmark, has climbed 34% since a low in mid-June to trade above $96 on a barrel Thursday — its highest level since last October — mainly on the back of extended output cuts by Saudi Arabia and Russia, as well as other members of the OPEC+ alliance of oil producers.

Falling US inventories of oil have confirmed the picture of tight supply — stockpiles at the closely watched Cushing, Oklahoma, storage hub plunged to nine-year lows last week.

America’s emergency stockpile — the Strategic Petroleum Reserve — has also plunged over the past two years after vast amounts of oil were released to shield consumers from the energy price shock caused by the Ukraine war. The dwindling reserve is limiting Washington’s ability to protect consumers from the fallout of Saudi Arabia’s aggressive supply cuts, Goldman Sachs has said.

Meanwhile, Russia is ratcheting up the pressure by also restricting exports of oil products such as diesel and gasoline — ostensibly to address shortages at home.

Giovanni Staunovo, a strategist at investment bank UBS, expects Brent to trade between $90 and $100 a barrel over the coming months, ending at $95 a barrel at the end of the year.

An ailing China

A slew of disappointing economic data out of China has also put pressure on stocks.

The world’s second-largest economy is mired in a debt crisis in its enormous real estate sector, and has record levels of youth unemployment.

Consumer spending, factory production and investment in long-term assets, such as property and machinery, all slowed in July, according to the country’s National Bureau of Statistics.

Despite a stronger performance in August, China’s economy has underwhelmed this year following the lifting of its strict zero-Covid policy in December. The boom in demand anticipated by investors as a result has so far failed to materialize.

In a reminder that China’s real estate crisis is far from over, shares in developer Evergrande Group and its two subsidiaries were suspended in Hong Kong Thursday, stoking doubts that it can restructure its huge debt pile and avoid liquidation. The company said later that its chairman was being investigated for alleged crimes.

High debt levels in the country’s property sector have raised fears of stress in parts of China’s financial industry, which has extended loans to developers.

For more CNN news and newsletters create an account at CNN.com