Financial Times Editorial - The return of fear to world stock markets
Financial Times Editorial - The return of fear to world stock markets
Published: May 20 2006 03:00 | Last updated: May 20 2006 03:00. Copyright by The Financial Times
Like a sudden storm on a clear day, the tempest that swept through the world's stock markets over the course of the past 10 days caught many investors by surprise. That storm abated yesterday but left the markets battered in its wake. Since peaking in late April/early May the FTSE 100 index has fallen 7.5 per cent, the S&P 500 4.6 per cent, the Eurotop 7.1 per cent and the Nikkei 225 8 per cent. During the three-year-long bull market that began in March 2003, there have been other corrections, all of which were short-lived. But this one may turn out to be more significant.
Even after the recent declines, world stock markets remain far above their 2003 lows. The FTSE 100 index is up 73 per cent, the S&P 500 58 per cent, the Eurotop 91 per cent and the Nikkei 112 per cent. It is too soon to say the bull market is over. However, the latest sell-off reflects changes in global conditions that will make further equity gains much more challenging.
One dramatic change is the increase in volatility. The Chicago Board Options Exchange VIX index, which measures market expectations of volatility, jumped from 11.83 on May 1 to a year-high of 17.31 in trading yesterday. While volatility is important in its own right, this jump reflects deeperconcerns.
The market is gripped by two scares: an inflation scare and a dollar scare. One of the most widely used measures of US inflation expectations, the spread between nominal and inflation-protected government bonds, has risen from 2.34 per cent on January 1 to 2.66 per cent yesterday. Rightly or wrongly, the credibility of the Federal Reserve under its new chairman, Ben Bernanke, is being openly questioned.
Meanwhile, equity investors have taken fright at the fall in the dollar since early April. The dollar recovered some ground this week, on expectations that inflation concerns would force the Fed to raise US interest rates further. But it remains down 3 per cent on a trade-weighted basis since April 1.
Of the two scares, investors should worry less about US inflation and more about the dollar (though the two are obviously related). All new Fed chairmen are tested by the markets. Mr Bernanke is no inflation dove, core inflation on the Fed's preferred measure is still only 2 per cent and the US economy is slowing towards trend.
The dollar is a bigger concern. While a steady and broad-based decline of the kind seen in late April/early May is both necessary and desirable, it could give way to a dollar rout and higher US interest rates. Much depends on Asian central banks, whose intervention to support fixed exchange rates frustrated a decline in the dollar in the post-dotcom bubble period, and their counterparts in oil exporting countries.
In valuation terms, the case for equities also looks weaker than it did a year ago. The rise in long term interest rates (from 4.4 per cent at the start of the year to 5.2 per cent in the US) means shares no longer look as cheap as they did relative to bonds. The yen "carry trade" (borrowing in yen at low interest rates and investing in higher yielding assets), which helped boost all risky assets, is fading away as Japan's economy revives.
If there is no cause for panic, then, there is cause for caution. Investors should expect more volatility ahead. With risk premia still very low by historic standards, there is little scope for outperformance by high-risk assets. If either the inflation scare or the dollar scare prove correct, shares could have a long way further to fall.
Published: May 20 2006 03:00 | Last updated: May 20 2006 03:00. Copyright by The Financial Times
Like a sudden storm on a clear day, the tempest that swept through the world's stock markets over the course of the past 10 days caught many investors by surprise. That storm abated yesterday but left the markets battered in its wake. Since peaking in late April/early May the FTSE 100 index has fallen 7.5 per cent, the S&P 500 4.6 per cent, the Eurotop 7.1 per cent and the Nikkei 225 8 per cent. During the three-year-long bull market that began in March 2003, there have been other corrections, all of which were short-lived. But this one may turn out to be more significant.
Even after the recent declines, world stock markets remain far above their 2003 lows. The FTSE 100 index is up 73 per cent, the S&P 500 58 per cent, the Eurotop 91 per cent and the Nikkei 112 per cent. It is too soon to say the bull market is over. However, the latest sell-off reflects changes in global conditions that will make further equity gains much more challenging.
One dramatic change is the increase in volatility. The Chicago Board Options Exchange VIX index, which measures market expectations of volatility, jumped from 11.83 on May 1 to a year-high of 17.31 in trading yesterday. While volatility is important in its own right, this jump reflects deeperconcerns.
The market is gripped by two scares: an inflation scare and a dollar scare. One of the most widely used measures of US inflation expectations, the spread between nominal and inflation-protected government bonds, has risen from 2.34 per cent on January 1 to 2.66 per cent yesterday. Rightly or wrongly, the credibility of the Federal Reserve under its new chairman, Ben Bernanke, is being openly questioned.
Meanwhile, equity investors have taken fright at the fall in the dollar since early April. The dollar recovered some ground this week, on expectations that inflation concerns would force the Fed to raise US interest rates further. But it remains down 3 per cent on a trade-weighted basis since April 1.
Of the two scares, investors should worry less about US inflation and more about the dollar (though the two are obviously related). All new Fed chairmen are tested by the markets. Mr Bernanke is no inflation dove, core inflation on the Fed's preferred measure is still only 2 per cent and the US economy is slowing towards trend.
The dollar is a bigger concern. While a steady and broad-based decline of the kind seen in late April/early May is both necessary and desirable, it could give way to a dollar rout and higher US interest rates. Much depends on Asian central banks, whose intervention to support fixed exchange rates frustrated a decline in the dollar in the post-dotcom bubble period, and their counterparts in oil exporting countries.
In valuation terms, the case for equities also looks weaker than it did a year ago. The rise in long term interest rates (from 4.4 per cent at the start of the year to 5.2 per cent in the US) means shares no longer look as cheap as they did relative to bonds. The yen "carry trade" (borrowing in yen at low interest rates and investing in higher yielding assets), which helped boost all risky assets, is fading away as Japan's economy revives.
If there is no cause for panic, then, there is cause for caution. Investors should expect more volatility ahead. With risk premia still very low by historic standards, there is little scope for outperformance by high-risk assets. If either the inflation scare or the dollar scare prove correct, shares could have a long way further to fall.
posted by Carlos T Mock at 12:32 PM
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