Market jitters keeps investors on their toes

Market players may be making decisions with all the savvy of headless chickens. Investors stampeded out of equity markets last week. And, in all the chaos that followed, some long-standing market correlations broke down.


Econometrix chief economist Azar Jammine identified one anomaly. Gold is seen as a hedge against inflation while bonds are seen as a hedge against deflation. So prices usually move in opposite directions. Yet last week both assets were on a winning streak.




Chris Hart, the economist at Investment Solutions, pointed out another anomaly. Although the gold price soared, the rand remained weak; and, while the value of US treasuries rose, the dollar did not.


The immediate trigger for the flight from equities was poor economic data from the US and Germany earlier in the week. Without economic growth, the US and heavily indebted European governments won’t be able to reduce their debt burdens, extending indefinitely the threat to global financial stability.


The danger for investors is that the recent scramble into gold and bonds could be building up two bubbles. And what will happen when the bubbles burst?


Last week’s sell-off in equity markets was the third since the downgrading of US debt by Standard & Poor’s earlier in the month. The re-rating alerted markets to the extent of the threat to the economic recovery in the US.


Jammine commented last week that he was surprised that it had taken financial markets so long to wake up to the danger.


Last week’s losses came despite the undertaking by the US Federal Reserve to hold its key interest rate at virtually zero for two more years, and despite the efforts of the European Central Bank to stabilise markets by buying Italian and Spanish bonds. This is an expensive remedy because it’s effectively printing money – a process that reduces the buying power of the euro. And the remedy hasn’t worked.


We have now started a new episode in the saga that began in 2007, when the US subprime market started unravelling. But are we getting any closer to the end?


We probably are because governments and central banks no longer have much fire power, after three years of intervention. But how will it all end?


Jammine predicts several years of very slow growth globally. While this is a gloomy prospect, it’s preferable to the alternative scenario of a series of asset bubbles – and their aftermath.


US and European bankers have been blamed for the financial and economic disaster that started in 2007. Rightly, because they were in the driving seat at the time, careening heedlessly through economic realities with offers of endless credit to fuel the consumer boom.


But they were not alone in their folly. One of the problems in advanced economies is that voters expect cradle to grave security – and life doesn’t provide that sort of blank cheque.


Politicians colluded in the illusion to get themselves into power. One of the ways they achieved this was by paying social pensions out of current revenue – unlike private retirement schemes which are obliged to have assets to cover their liabilities. The formula worked for decades but its efficacy is about to expire.


Europe, in particular, can see the writing on the wall as its working age population shrinks in relation to pensioners. So reality intrudes.


And, after being fed a steady diet of wishful thinking, since the end of World War II, voters won’t like reality. This creates a new challenge for politicians.


Source -http://iol.co.za
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