What’s behind the spooked stock market?

By Anatole Kaletsky
May 30, 2013

Strange things have been happening in the world economy and financial markets this week. While that sentence could be written almost any time in the past five years, since the outbreak of the global financial crisis, the strangeness this week has taken a particular form that reveals more than it confuses.

Almost all the economic news recently has been favorable, or at least better than expected. U.S. home values have risen more than at any time since 2006, job losses are down and consumer confidence has been restored to pre-crisis levels. Japan has enjoyed its fastest growth in years, with evidence mounting of stronger consumption and rising wages. Even in Europe, the outlook appears to be improving as policy shifts away from austerity and toward growth, with the European Commission no longer pressing governments to hit their deficit targets. Meanwhile, the European Central Bank hints at the possibility of negative interest rates and other extraordinary stimulus measures. But financial markets have reacted to all this good news by becoming more volatile – panicky, even – than at any time this year.

Although the U.S. stock market briefly hit a record high on Tuesday, prices quickly slumped. Meanwhile, Japanese shares have suffered their steepest fall since the 2011 tsunami. Most importantly, bond markets have collapsed the world over, pushing long-term interest rates in the United States, Japan and much of Europe to their highest levels in more than a year.

What is going on? The clues are provided by the last market upheaval, the one in interest rates and bonds. Plunging bond markets have spooked equity investors because share prices are related in one way or another to the yields on U.S., Japanese and European bonds. And fears about volatile interest rates and wild stock market gyrations could soon infect consumers and business decision-makers in the non-financial world.

These fears raise three questions. What is causing the sudden financial anxiety? Are these worries justified? And should policymakers do anything to calm the markets, or alternatively to break the link between gyrating financial markets and the non-financial economy of consumption, business investment and jobs?

The answers are surprisingly clear. There is not much dispute that the outbreak of volatility has been caused by the U.S. Federal Reserve Board – specifically by last Wednesday’s congressional testimony from Ben Bernanke and the publication of Fed committee meetings a few hours later. While I argued in this column last week that Bernanke said nothing new, merely reiterating the Fed’s commitment to keep stimulating the U.S. economy until his target of 6.5 percent unemployment was clearly within reach, the markets took a very different view: that the Fed was preparing to start reducing its monetary stimulus, perhaps as early as next month.

There was no real evidence for this belief, and indeed Bernanke, along with several influential Fed officials, emphasized the danger of withdrawing stimulus before a strong economic recovery was well established. But many investors and media analysts were unconvinced, partly for the reasons of social psychology discussed here last week – and even more important, as the week wore on, by an additional psychological factor. The very fact that bond markets moved so sharply after Bernanke’s comments last week made investors believe his comments must have contained significant new information. The more prices moved, the more investors became convinced that the market “must know something” about the Fed’s intentions, even if this was not apparent from Bernanke’s words. This kind of feedback is an example of what George Soros calls reflexivity – the ability of market expectations to change economic reality, bringing reality into line with expectations, whether the expectations were misguided or justified.

Which raises my second question: Is there any reason to believe that monetary stimulus will soon be reduced or withdrawn? There are two broad reasons to doubt this. First, Bernanke and other Fed officials have repeatedly said they would consider reducing stimulus only if they were confident about the momentum of growth and job creation. To judge such momentum would require at least six months of consistently strong employment figures or two quarters of solid growth in gross domestic product. Given the erratic statistics published in March and April, it is literally impossible for such a run of strong figures to materialize before the fourth quarter of this year. Second, Japan and Europe, which have only just gotten out of austerity mode, are certain to continue providing the world economy with more stimulus even after the Fed’s monetary expansion begins to subside. Combining the efforts of U.S., Japanese and European central bankers, therefore, global monetary conditions are almost certain to become more, rather than less, stimulative for at least another year or so.

It seems, then, that market fears of monetary tightening are almost certainly unjustified, or at least very premature. In which case, should anyone care about the recent stock market and bond gyrations, still less about taking action to calm the markets down? Unfortunately, the answer is yes, because of the reflexive interaction between financial markets and economic reality. Although the global economic recovery is becoming stronger, it is still too fragile to withstand a serious financial shock. If equity prices were to fall sharply or long-term interest rates to rise much further in the next few months, consumer confidence, business investment and housing would all suffer and government deficits would start to widen again. In short, a financial shock could damage the global economy to the point where deteriorating economic reality would ultimately justify the initial financial shock.

To avoid such a self-fulfilling downward spiral, central bankers and governments in every major economy should make clear that monetary conditions are not about to be tightened . And they should remind investors that, although a gradual increase in long-term interest rates is a healthy development as the world economy returns to normal, central banks have unlimited monetary firepower when it comes to protecting their economies from excessive interest-rate movements or sudden volatility in financial markets.

PHOTO: A pedestrian holding an umbrella walks past a stock quotation board showing various countries’ stock prices outside a brokerage in Tokyo May 30, 2013. REUTERS/Yuya Shino

 

12 comments

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This article seems to have originated from another, happier dimension of the universe. The global recession is recovering? The depression in Europe is turning around? France is now in recession. The growth rates in China and India are declining with signs of bubbles collapsing (housing and debt). Brazil has been in recession for almost two years. Japan’s economy is going nowhere. Real US unemployment – long-term unemployed measured by the participation rate – is growing worse. Why do we have all these articles that say that the world’s second largest economy, Europe, is in deep trouble, getting worse and with no respite in sight?

I’d like to ride that inter-dimensional bus to utopia.

Posted by ptiffany | Report as abusive

So how do you establish facts? Let’s say you state something like ”home prices accelerate by most in seven years”, a bit looks really good at first glance, then you take a second look… at fundamentals, and there’s a dud. You see that homes are bought by those ”broken transmission vehicles” that are supposed to deliver the dough to the people. Interpret this heist as you will, but these homes are vacant as they were and Wall Street investors who own them will do nothing for common and/or durable good(s).

Or this pamphlet that arrived from EC today… browse the comments from here to local news outlets that carried the word and you can clearly see that sentiment (confidence) of the people isn’t represented in assessment of unelected.

We’ve learned to take Chinese data with the nervous bite on a lip or pinch of a salt or whatever is the say too, because we’ve established as fact that it tends to get fudged.

(…)

This uncertainty in interpretation (of propaganda) is reflected on Reuters too; these days it has reached… well I do find it a bit humorous in extent, since we have shifts in evaluation and interpretation of the data on daily basis. It even affected your column, dear Kaletsky, in sense that ”restoration of job losses” continues after official revision that’s been published today.

(…)

Personally, I was surprised to see, couple of months ago, that usually sober ZEW showed… willingness to exercise power of positive thinking or, perhaps, urge to escape the reality of our surroundings… which, I’d guess, has potency to make certain people really spooked.

Posted by satori23 | Report as abusive

So, your “remarkably simple” solution is to keep the “Wealthy Welfare” going forever.

As long as these people are playing with the “house money”, the markets will continue to rise. However, when their “credit card binge” is cut off — or even threatened to be cut off — they panic.

THAT is what is really going on. Yes, it IS very simple, but not at all like your bullshit story to keep readers mollified, lest someone begin to understand what is happening.

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Bubbles Inflating Faster Than GDP
May 14, 2013 posted by Guest Blogger

By Michael Pento

Three reasons why an economy soaked in debt grows only bubbles.

Global central banks have clearly demonstrated the ability to re-inflate stock and real estate bubbles. Global stock markets are roaring ahead of their economies and real estate prices are quickly rebounding from their recent collapse. However, rock-bottom interest rates and massive money printing have yet to show an aptitude for creating sustainable GDP growth.

There has been a lot of talk about a rebound in the equity and real estate markets helped along by the Fed’s free money. That much is for sure the truth; but the evidence of a viable and sustainable recovery built on free-market forces just isn’t there.

For example, the percentage of consumers who own their own home continued to fall during the first quarter of 2013, dropping to a national level that hasn’t been seen since the fall of 1995. The Census Bureau reported that the nation’s homeownership rate slipped to 65% in Q1 2013, a decline from 65.4% posted in the last quarter of 2012. The rate of home ownership now stands at a 17-year low!

But if the housing market was gaining ground on stable footing then why aren’t first-time home buyers and owner occupiers participating? Instead, it has been hedge funds and speculators that are sopping up all the foreclosures. One has to wonder if these “investors” will hold onto their rental properties if the economy tanks once again and home prices take another steep drop.

In addition, the labor market isn’t rebounding as the Fed had hoped and projected it would. Last month’s NFP (National Financial Partners Corp.) report showed that, despite $85 billion per month of Quantitative Easing, 9,000 goods-producing jobs were lost. And even though you hear the mainstream media talk about resurgence in the manufacturing sector, there were zero manufacturing jobs created in April. What’s even worse is that aggregate hours worked fell by 0.4% in April over March. Therefore, despite the fact that the Labor Department says that 165,000 net new jobs were created, the actual total number of labor hours worked was in decline.

There is a reason why the Fed and other central banks have been unable to achieve a healthy and viable economy even after five years of trying to manufacture one from a printing press. The truth is an economy soaked in debt just doesn’t grow because it is always marked by at least one, if not all three, of the following growth-killing conditions: high interest rates, rampant inflation and onerous tax rates.

Any country with outstanding debt equal to or greater than its GDP is forced into sucking an exorbitant amount of capital out of the private sector due to burdensome rollovers and interest payments on that debt. In addition, rising tax rates act as a disincentive to increase productivity, and whatever money is taken from the private sector is always redeployed in an inefficient, GDP-destroying manner. Rising interest costs also discourage borrowing and lead to capital shortages. And finally, inflation destroys the purchasing power of the middle class by eroding the value of the currency and leaving consumers with an inability to make discretionary purchases.

But central bankers don’t acknowledge this truth and are instead seeking to increase their efforts in pursuit of ever-increasing money supply growth. Of course we are all familiar with the counterfeiting undertakings of the Fed and Bank of Japan. Now Australia’s central bank is joining the crowd of inflation lovers and has cut its key interest rate by 25 basis points on May 7, to a record low of 2.75%.

Investors need to be aware that if a central bank wants to set an inflation target it will be achieved. European Central Bank President Mario Draghi said recently that the ECB was “technically ready” to shift the deposit rate into negative territory, meaning it would start charging lenders for holding their money with the central bank. A bank cannot accept a negative return on its assets. Therefore, if Draghi follows through on his threat, expect money supply growth and inflation to kick into high gear over in the eurozone.

The bottom line is that central bankers are totally inept at creating economic growth but extremely proficient at building asset bubbles. Inflation targets will be met and exceeded as they deploy their new “tools” of charging interest on excess reserves and buying up the stock market. They are in the process of rebuilding the equity and housing bubbles and have already created a massive bubble in the sovereign debt of Europe, America and Japan. Once this bubble breaks (like every other bubble has done in the past) expect economic chaos in unprecedented fashion.

Mr. Michael Pento is the President of Pento Portfolio Strategies and serves as Senior Market Analyst for Baltimore-based research firm Agora Financial.

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http://www.prudentbear.com/2013/05/bubbl es-inflating-faster-than-gdp.html#.Uae-3 5ymhVI

Posted by EconCassandra | Report as abusive

Everyone knows the stock market is in a bubble. Their issue is there are no alternative passive investments. This is why everyone jumps at their own shadow.

Posted by BidnisMan | Report as abusive

I just can’t get this image out of my head……..

there is this guy, in a big car, with a leak in his right front tire……..he’s still driving on tire, he hasn’t changed it.

and, he pulls over every 2 miles to pump air into the tire.

he tells the passengers, ‘everything is fine, we’ll get there’.

……and I’m wondering if it’s gonna go flat on the freeway

Posted by Robertla | Report as abusive

Mr. Kaletsky, you state “Even in Europe, the outlook appears to be improving as policy shifts away from austerity and toward growth.” REALITY CHECK!

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Eurozone unemployment hits new high with quarter of under-25s jobless

Overall eurozone unemployment rose to 12.2% in April, with young jobless rate up slightly at 24.4% from 24.3% in March

Katie Allen
guardian.co.uk, Friday 31 May 2013 07.03 EDT
Jump to comments (42)

Eurozone unemployment has hit a fresh high with young people the hardest hit as now almost one in four under-25s are out of work in the crisis-stricken currency bloc.

Eurozone unemployment rose to 12.2% for April, an all-time high, according to Eurostat, the statistics office of the EU.

At 24.4%, youth unemployment was double the wider jobless rate and up from 24.3% in March. The problem was most extreme in Greece where almost two out of every three under-25s are unemployed. The rate was 62.5% in February, the most recently available data.

The numbers come just days after eurozone leaders announced plans to get more young people into work as they face warnings about the risks of civil unrest and long-term costs to their economies.

Economists forecast that joblessness will get worse before it gets better in the eurozone.

“An end to the eurozone labour market downturn is not yet in sight. Even if the eurozone economy exits from recession later this year, the labour market is likely to remain in recession until next year,” said Martin van Vliet, at ING Financial Markets.

In the wider EU area of 27 countries, unemployment stood at 11%, as the rate increased in all but nine countries compared with a year earlier.

The biggest rises in joblessness on a year ago were in Greece, Cyprus, Spain and Portugal.

But economists noted that the increase in unemployment was fairly broad-based with rises in so-called core countries as well, including Belgium and the Netherlands, while French unemployment held at 11%.

“Eurozone unemployment has now risen for 24 successive months and by a total of 3.853 million since starting to trend up in May 2011,” said Howard Archer at IHS Global Insight.

He added: “About the only positive spin that could be put on the eurozone unemployment data is that the rise has shown some signs of slowing overall in recent months. The increase has averaged 82,000 a month over the past three months compared to an overall average monthly increase of 158,000 in 2012.”

Ireland recorded one of the biggest drops in unemployment, down to 13.5% from 14.9% a year ago. That compares with a rate of 7.7% for the UK, where youth unemployment is 20.2%.

The lowest rates for youth unemployment were in Germany at 7.5% and Austria at 8%.

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http://www.guardian.co.uk/business/2013/ may/31/eurozone-unemployment-new-high-qu arter-under-25s

Posted by EconCassandra | Report as abusive

The markets are spooked because the use of misdirection by bull market advocates to the effect that liquidity from central banks will float prices regardless of fundamentals is just plain stupid.

Posted by keebo | Report as abusive

No one see the value, only the profit takers waiting for enough twits to stick their life savings in, before there is a “correction”. Get the moron CEOs and creepy board members to put money into real things. Look, you got the money of the simpletons who bought the brainwash. The people left with cash don’t believe the crap you speak.

Posted by brotherkenny4 | Report as abusive

There is no longer a stock market in the classic sense. The Fed has killed it. Professional investors control the “stock markets” and invest through automated accounts that can react in literal micro-seconds to a set of conditions they have been programmed to recognize. They all know there is a Fed-induced stock bubble, which means they all know a crash is pending. They don’t know when, but there will be allowances for this in the algorithms; and some bizarre outcomes can result. Trying to relate market behavior to anything other than Fed behavior (or anticipated behavior) is sheer folly. All the pundits who continue to try to relate market behavior to other externalities should be out of a job.

Posted by Pat_Rich | Report as abusive

I’m going to go out on a limb here, and say that while he might be correct (who knows?), there is another possibility. Much like Microsoft’s Marketing branch, whose glowing estimates of Windows 8 probably came purely from internal statistics (much to the chagrin of MS), so to are these marvelous proclamations of the ‘market clearly wants this or that.’ In other words, they really have no clue what the market wants, but are hoping that the usual rituals and waving of the hands will fool people long enough for the market to recover, and make them look good (“See? You just needed to wave the palm branch like *this*”). The market appears to know what it does and does not want, and it does not appear to like what it’s getting at all.

Let’s take a closer look at things, shall we? The market, in its current state, is a bit distanced from its ideal form…every government on the planet has its hooks placed into its sides, and they’re all jockeying for a better position. But it’s not just them…it’s also the various corporate types who rent hooks from host governments to maneuver the market here and there. In the US, in recent times, you have out of control student loans, mortgages, toxic securities, bank bailouts, corporate bailouts, etc. that are, at best, perversions of the ideal market form. You have people’s lives and futures being destroyed…and the sad part is, the ones getting hit are the people on the sidelines. It’s not the idiots who start these financial wars who are getting hit, it’s the poor people who lack the funds to even be involved in these wars.

And the worst part? Debt is multiplying, not wealth; debt with no ability to repay, and no representation in higher places to simply say “This cannot stand.”

Posted by rossryan | Report as abusive

Sorry, but Reuter’s had stocks rated above neutral forever. Most were even outperform when everything was taking a **it!! Very hard to use as a source in the past. Prove me wrong?

Posted by GeoWorries | Report as abusive

This is getting a bit more subjective, but I much prefer the Zune Marketplace. The interface is colorful, has more flair, and some cool features like ‘Mixview’ that let you quickly see related albums, songs, or other users related to what you’re listening to. Clicking on one of those will center on that item, and another set of “neighbors” will come into view, allowing you to navigate around exploring by similar artists, songs, or users. Speaking of users, the Zune “Social” is also great fun, letting you find others with shared tastes and becoming friends with them. You then can listen to a playlist created based on an amalgamation of what all your friends are listening to, which is also enjoyable. Those concerned with privacy will be relieved to know you can prevent the public from seeing your personal listening habits if you so choose.