Markets see another day of heavy losses, Italy has emerged as the country they fear, but then Argentina and Turkey are not far behind. But at least one closely watched signal, does not look that scary at all.
Markets maybe in turmoil, but some signals: not so bad
22nd May 2018: the FTSE 100 hits a new all-time high. May 29th, the index is down by 245 points from that peak, off three per cent. Normally, a three per cent fall over two days would feel quite dramatic, but then considering the index has merely fallen back to the level it was around two weeks ago, that is not so extreme.
Almost every day I am getting emails from financial publications warning me of another great crisis around the corner, and then, when the eminently predictable Italian crisis starts to look serious, I get emails telling me ‘told you so.’ So far, though, for all the hype, as far as US and UK stocks are concerned, it all feels a tad mild.
Take the VIX index, a measurement of volatility which looks at the moving average of the S&P 500. Yes, it spiked yesterday, as one would expect given the situation in Italy. The index, which is also known as the Fear Index hit 18.61 at one point yesterday, that is double the level it was at for much of last year. Even so, it was higher in April, a lot higher in March, and double that level at the beginning of February. The markets seem to be telling us that there was more reason for caution earlier in the year.
This all begs the question, what happened earlier this year that was so scary? Well, Trump revealed plans for a trade war, and the Italian election happened in March, and the two parties that gained the highest votes were the populist left wing Five Star Movement and the populist Right wing Lega. What would they do?
Well, they put forward a manifesto that involved spending and tax cuts, (A bit like Trump, come to think of it), but much watered down from election promises, and no one seemed to so much as batter an eye-lid. Then the Italian president rebelled, refused their plan, and appointed an ex IMF economist as Prime Minister, with another election planned for the autumn, and the markets went into tailspin. In short, the markets are panicking over the very real fears that the Italian people won’t vote for the policies that the markets prefer.
It shows one thing. The economy matters, as do metrics such as unemployment and inequality. It often frustrates me. Sometimes markets boom, when unemployment rates are high, and when data shows rising inequality. ‘What has that got to do with the stock markets’, ask the hardened Gordon Gekko types? Well, it has a lot to do with the markets. When you get sustained periods of unemployment and or inequality, and a sense of unfairness, electorates don’t do as they are told, and vote for parties which the markets are terrified of.
Emerging markets have been seeing heavy losses too. These losses were predictable and have been signposted here enough times. US interest rates are going up after an extended period when they were exceptionally low. I am not sure that there has ever been a time when a period of low interest rates, followed by a period of rising rates, was not followed by some kind of financial crisis.
Rates went up in the mid-1990s, following a period when they were exceptionally low and in 1997 we had the Asian crisis, followed by the Russian crisis and the collapse of LTCM. Rates went up in the middle of the noughties, after a period when they were exceptionally low, and we got the crisis of 2008.
US interest rates are going up again, this time after a period when they were at record lows for nigh on a decade, while central banks used quantitative easing to drive up asset prices. Of course, this is going to create some kind of crisis.
And yet when I look across the global economy, I see debt levels that are not as high as in 2008 – in most cases. I see some vulnerabilities, aside from Italy, there are issues in Spain, where the government is looking increasingly forlorn, but then the Spanish economy has seen a marked improvement over the last two or three years. Remember too, that across the euro area, unemployment is at its lowest level since 2008.
In emerging markets there have been various concerns. Turkey is in a bad way, and matters are not helped when President Erdogan decides he knows more about monetary policy than the central bank. Turkey’s big problem has been its massive current account deficit – it was always going to end in tears. As for Argentina, I had to pinch myself when I read it was borrowing money from the IMF. Argentina is the classic example of what happens when a strong economy allows too much inequality – that was around a century ago, of course. The problem besetting Argentina, at the moment, relates in part to a reduced appetite for its commodities from China. While President Marci, who came to office a year ago, heralded as a man that the markets could trust, put too much faith in foreign investors. Now that US interest rates are going up, those same investors are pulling their money back home.
Recently the Harvard economic professor Carman Reinhart warned that Argentina, Turkey and Peru have the worse combination of current account vulnerability and poor government effectiveness, but she also suggested that Brazil, Indonesia, Mexico, the Philippines and India were not far behind. But then the Reinhart study also suggested that Thailand is strong, yet this country has suffered a real estate bubble that seems to have burst.
What happens in China and the economy stupid
These days, most of the Asian economies are more reliant on China than they are the US. If China can stay strong, then most emerging markets can weather the storm. As for the developed world, it’s the economy that matters. In the long run, economic growth and stock market strength are aligned. I’ll take another look at these issues in the next week or so.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees