Opinion

Anatole Kaletsky

What’s behind the spooked stock market?

Anatole Kaletsky
May 30, 2013 16:14 UTC

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?

Has a new long-term bull market begun?

Anatole Kaletsky
May 9, 2013 16:06 UTC

Two months ago, when Wall Street first approached a record high, I warned about the dangers of “stock market vertigo” – a condition that combines the fear of buying shares at unsustainably high prices with the equal dread of not buying shares at prices that will never again be on offer if the market soars to permanently higher levels.

At that time the world’s most closely followed index, the Standard and Poor’s 500, was still bouncing along the top of a trading range that had held since the bursting of the Internet bubble in March 2000. There was no way to know whether the market’s next big move would be a plunge back toward the middle of this 13-year range or a rise to new and significantly higher records. On one hand, improvements in the U.S. economic outlook and political situation at the end of last year suggested that a breakout was more likely than the last time the index came close to its 2000 peak ‑ in late 2007, when the subprime mortgage crisis was just starting and George W. Bush was still president. On the other hand, the European crisis looked as bad as ever, China seemed to be slowing, corporate profits were stalling and investors were well aware of the huge losses suffered by people who got sucked into the market when it hit similar levels in 2000 and 2007. There was no sure way to resolve this dilemma two months ago, and there still isn’t, since prices in financial markets are always balanced, by definition, between bullish and bearish expectations that are roughly equal in plausibility.

But the market’s behavior sometimes suggests an answer – and this week appears to present such a case. In the week since last Friday, when the United States reported much stronger than expected employment growth, the S&P 500 has moved more than 4 percent above the 13-year trading range defined by the 2000 and 2007 highs. This breakout has been confirmed by the Dow Jones industrial average and by broader Wall Street indexes, such as the Wilshire 5000 and the S&P equal-weighted index. And while share prices in most other countries are still far below their 2000 and 2007 levels, the Tokyo stock market has taken off like a rocket and Germany’s DAX has matched Wall Street’s ascent.

Don’t worry about a stock market drop

Anatole Kaletsky
Mar 14, 2013 15:50 UTC

A feeling of vertigo may seem natural as Wall Street approaches a record and stock markets around the world climb to their highest levels since 2007. With the Standard & Poor’s 500-stock index  now only 0.5 percent away from its 2007 high of 1565 and with the Dow Jones industrial average scaling new peaks almost daily, what will investors expect to see when they reach the mountaintop? The mountaineering analogy suggests, at best, a long descent and, at worst, a precipitous drop. But how literally should we take such metaphors?

Bearish analysts often claim that stock market peaks have always been followed by sharp falls, citing as evidence the record high of October 2007, which was quickly followed by a 57 percent collapse in 2008-09. They add that the previous peak, in March 2000, was followed by a 37 percent plunge and that last major high before that, in August 1987, preceded the biggest-ever market crash, in October 1987. These precedents, along with the even more vertiginous peaks of 1989 in Japan and 1929 on Wall Street, certainly sound scary, but they are meaningless.

It may be true that all major market peaks have been followed by big declines, but the reason is semantics, not finance or economics. A peak is, by definition, a high point followed by a decline. A new market high that is not followed by a fall in prices is simply not called a peak. A record of this kind, far from preceding a steep decline, tends to act as a staging post for higher prices. Looking back through history, it turns out that this benign type of record, paving the way for higher prices, is actually the norm.

Is the current market optimism justified?

Anatole Kaletsky
Jan 31, 2013 18:39 UTC

The U.S. economy has just suffered its first contraction since 2009, consumer confidence has plunged since November’s election and Americans’ paychecks are only just starting to reflect an increase in payroll taxes averaging $70 per month. Across the Atlantic, the euro zone and Britain seem to be sinking back into recession. And conditions in Japan have become so desperate that newly elected prime minister Shinzo Abe is openly devaluing the currency and threatening to take direct control of the central bank.

At the same time, stock markets around the world are approaching or exceeding records. Money is flowing into equity mutual funds at the fastest rate since the end of the last bull market in 2000. And business sentiment, as reported from Davos, seems to be more optimistic than at any time since the global financial crisis of 2008.

Is there a rational way to explain these contradictions? Will the business and market optimism be sustainable? Or is this sudden euphoria just another financial bubble, sure to be punctured if the grim message from recent economic indicators sinks in? The likely answer to all these questions is yes.

Europe has lost its ability to surprise

Anatole Kaletsky
Jul 4, 2012 19:31 UTC

Last Friday global stock markets and the euro enjoyed their biggest one-day gains of the year. The S&P 500 jumped by 2.5 percent and the euro by 1.8 percent against the dollar. This Friday we will find out whether these moves were just a blip. Why this Friday? Because that is when the U.S. government publishes its monthly employment statistics – and these figures have more influence on global markets than anything that European leaders may or may not decide.

There are four reasons to believe this. The first is the very fact that Europe so dominates the news. Financial markets are not moved by events; they are moved by unexpected events. Once a story has appeared on newspaper front pages around the world every day for months, what are the chances that it will radically surprise? At this time last year, there was still widespread misunderstanding and complacency about the European crisis. The European Central Bank, for example, was so complacent that it was raising interest rates when it should have been cutting them. But today, investors and policymakers are obsessed with Europe’s grim prospects. A genuine surprise would have to be something much worse, or much better, than the scenarios market participants already know.

This observation leads to the second reason for shifting attention from Europe. For Europe to generate a favorable surprise that lasts for more than a few days or weeks is literally impossible. The market is too aware that for the euro to survive it has to go through a  lengthy and uncertain process of political federation. But Europe’s capacity for negative surprise is quite limited too. Everybody knows that Europe is in deep recession, that Greece will never repay its debts, that Spanish banks are insolvent, that debtor countries will all miss their budget targets and that German-imposed austerity will prolong the recession for years. The only news from Europe that would shock the markets would be a total breakup of the euro and Lehman-style financial meltdown. Such a breakup is possible, but it isn’t yet the most likely scenario. Unless a breakup happens, Europe will create lots of volatility, but the trend in financial markets will be set by events elsewhere.

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