Is it all over? Where will the market rollercoaster take us next?

By Cliff Taylor

Five questions in the wake of the extraordinary Black Monday stockmarket volatility

1. I see European markets are up today. Is it all over?

Despite big falls in China overnight, where the market lost another 7.5 per cent plus, European markets are up today – Irish shares gained over 4 per cent – and US markets are also stonger.

There seems to be a general view that the sell-offs of Friday and Monday – in which many of the big markets and our own ISEQ index lost around 10 per cent – were overdone.

However Monday’s volatility was extraordinary, particularly in the US, and nerves are still on edge. With huge uncertainties still over the outlook for China and the ongoing debate about the health of the big developed economies it would be a brave person who said that things would all settle down quickly. No-one knows, but the ingredients for further volatility remain and trends later today will be interesting in themselves.

2. How do stockmarkets suddenly swing around so much?

There is a lot playing in to this – the end to summer trading, the fact that China does not have a big institutional investor base and is thus more prone to volatility, and the swings in the background in currency markets, notably for the currencies of emerging markets and commodities.

But lying behind this is one simple thing – a disagreement over the outlook for the world economy. The bears believe that shares in the big markets have been overvalued for months now and are pricing in growth in profits which are not justified by economic fundamentals.

So they see what is happening in China as a warning sign for world growth and predict a sell-off. Those who have been bullish in recent months argue that even if China is slowing, the economy there is still growing and the big developed economies are slowly recovering, led by the US. As the old saying goes, “ two views make a market” , though normally not one as volatile as this.

3. How do we assess what is happening in China?

It is difficult. In the developed economies, analysts obsess over every new piece of economic data. China’s officially controlled figures do not tell the whole picture, though it is clear that exports and the manufacturing sector have slowed significantly.

This has had a big impact on commodities – China’s fast growing economy is a big purchaser of things like iron ore and oil. The Chinese authorities have intervened to stop their currency from falling further after recent devaluations, though they seem to have stepped back from supporting share prices in recent days. This morning the Chinese central bank cut interest rates for the fifth time in nine months, reducing its one-year rate by 0.25 per cent to 4.6 per cent, in an attempt to boost activity.

China’s stock market is still controlled in many ways by the authorities, but not entirely – as we are seeing – with small investors taking a heavy hit as shares on average have lost 40 per cent plus of their value in recent months.

4. What about currencies?

The currencies of many emerging markets such as Russia have been under pressure for months now and fell again after China let its currency devalue a couple of weeks ago.

However the big surprise has been the flow of funds in to the euro, which has risen sharply in recent days, apparently being seen as some kind of safe haven for investors.

The euro has risen to around $1.17, erasing around half its loses against the US currency this year. This will not please the ECB, who had hoped that the monetary easing programme they are undertaking would weaken the currency and boost exporters selling outside the euro zone.

The euro eased a bit this morning and it is not clear where it goes next, but a weaker euro is generally to Ireland’s benefit as a country with big export sales in the US and UK.

5. And interest rates?

Isn’t it amazing? US base interest rates are at 0 per cent and there is a big argument about when they are going to nudge up to 0.25 per cent. Perhaps it is the signal of the policy change that is important, and the fact that it would suggest more is to come.

Forecasters are now divided on whether the US Fed will raise rates next month or hold off. In turn this leaves the Bank of England waiting and seeing, as it is expected to follow the Fed.

With European growth still low and falling oil prices likely to hold down overall prices, all the signs are that euro zone rates will stay where they are and that the ECB will continue with its programme of monetary stimulus. It is going to be an interesting Autumn.