Stocktake: Market fear refuses to fade
Wild price swings show role animal spirits currently play in financial markets
The charging bull statue near the New York Stock Exchange on Wall Street. Investors keep getting wrong-footed by the market swings. Photograph: Mandel Ngan/AFP/Getty Images
Things are getting increasingly hairy in global markets. Last Thursday was the worst day for European stocks since the Brexit vote in June 2016. Things were looking similarly grim on Wall Street before a stunning late-day turnaround.
Investors keep getting wrong-footed by the market swings. Many were lulled into thinking the worst was over, with stocks rebounding strongly following recent dovish comments from Federal Reserve chairman Jerome Powell and an apparent easing of trade tensions between the United States and China, but the relief didn’t last long. The Fed had been blamed by many (including President Donald Trump) for market weakness in recent months, but last week’s action strongly suggests the focus on the risk of excessive monetary tightening has been overhyped. After all, stocks plunged even though futures prices increasingly suggest rates may not now be hiked even once next year.
Right now, investors are much more concerned by the escalation in US-China trade tensions, as evidenced by the panicked reaction to the arrest of Huawei Technologies chief financial officer Wanzhou Meng last Thursday. Bank of America estimates the trade war has wiped some 6 per cent off the S&P 500 this year.
Still, fundamentals alone cannot entirely explain the market action – the wild price swings are evidence enough that animal spirits are playing a large role in financial markets right now.
Don’t panic over yield curve inversion
It seems everyone is freaking out about last week’s inversion of the US treasury yield curve, something that preceded each of the last nine US recessions. Time to panic? Ordinarily, long-term bonds yield more than short-term bonds, rewarding investors who must wait longer to get paid. The yield curve has been flattening throughout 2018, however, and last week three-year bond yields exceeded five-year yields, the first inversion since July 2007.
However, talk of imminent recession is premature, for two reasons. Firstly, “not all spreads are equal”, notes LPL Research. One-year yields exceeding 10-year yields has much more predictive power than last week’s inversion of three- and five-year yields (for example, this same phenomenon happened in August 2005, 28 months before the US recession began). That’s echoed by money manager Richard Bernstein, who describes last week’s partial inversion as the “latest hair-on-fire event”. Of course, a more traditional inversion may follow, but it’s equally true that flattening yield curves can persist for years. However, investors shouldn’t assume the worst even if there is a near-term inversion in one- and 10-year yields. This is a long leading indicator; looking at the last five recessions, LPL notes the S&P 500 didn’t peak for more than 19 months, on average, after the yield curve inverted. Over those periods, stocks averaged gains of 22 per cent, suggesting an equity Armageddon may be some way off yet.
Focus on percentages, not points
There have been only six days historically when the Dow Jones index moved 800 points or more, tweeted Gluskin Sheff strategist David Rosenberg last week. There were two up days (both in 2008) and four down days, all of which occurred this year. And that, he added, is “how you know you’re in a bear market!”. Really? Reporting market moves in points as opposed to percentages is a cheap trick usually used by statistically illiterate scaremongers, not high-profile strategists such as Rosenberg, who famously called the global financial crisis in 2008 while working at Merrill Lynch.
The Dow was about 1,000 in 1980; it crossed 10,000 in 2000; and is at about 25,000 today. Thus, an 800-point drop would have been a move of 80 per cent in 1980, 8 per cent in 2000, and about 3.2 per cent today. Thus, last Wednesday’s 800-point drop was the fourth worst in history in points terms, but only the 329th worst in terms of percentages. There have been five days this year where stocks gained or lost 3 per cent, not nearly as many as in 2009 and 2010 – both very strong years for stocks. Big one-day moves, whether to the upside or downside, are a potentially bearish development, reflecting mounting jitters, but the recent action isn’t nearly as unprecedented as Rosenberg is suggesting.
Roubini delights in bitcoin meltdown
The meltdown in bitcoin prices continues, and no one is happier than cryptocurrency sceptic Nouriel Roubini. The economics professor, known as Dr Doom for his dire warnings prior to the 2008 global financial crisis, just loves putting the into bitcoin, or shitcoin, as he often calls it. “I could gloat” about the collapse in prices, he tweeted last month, but the price “is still some way to ZERO where Bitcoin belongs”. He hasn’t eased up since then, as evidenced by last week’s tweets. Bitcoin is the “most overhyped and useless technology in human history”, loved by an “ideological soup of starry-eyed techno-utopians & sketchy-ass crypto-grifters”, “crypto-lunatics” who spout “the biggest pile of baloney manure nonsense!” But tell us what you really think, Nouriel.