Financial Markets Volatility

Lawrence Zammit's article on The Times of Malta

At the beginning of this week, financial markets became very edgy and heavy losses were reported in the indices of stock exchanges around the world. It is understandable that this event caused a great deal of panic, as the major economies would certainly have not wished the current economic recovery to have been so short-lived, following the deep recession of 2008 and subsequent years. Fear set in of another deep recession.

It is worth asking what happened to trigger the drop in equity prices. Is this the build-up to another recession? Is there reason to be concerned? A number of considerations emerge.

Analysts have put the blame on computers. They are arguing that operators have developed computer algorithms, such that when prices of equities hit a particular level, an order is given automatically, to buy or sell. So the decisions to sell equity last Monday were not made by persons but by machines.

This may well have been the case. However, these algorithms were designed months or years ago. Since then the context has changed. So are traders relying solely on machines that are incapable of distinguishing between one market situation and another? Can they trigger a financial crisis and we would be totally helpless to stop it?

The second consideration is whether the drop in the value of equities was a correction or indeed a crash. Here history and numbers help us to understand that this was really a correction of the market. The New York Stock Exchange Index fell 5% last Monday.

At the time of the Wall Street Crash of 1929, equities fell by 25% over two days. In 1987, equity prices fell by 20% in one day. So relatively speaking the 5% drop of last Monday cannot realistically be described as a crash. It is seen as a crash because interest rates are still low, and there may be very few investment alternatives to equity.

What happened this week should really be seen as a correction resulting from changed economic circumstances. Interest rates are rising again in the United States. There are indications that there could be three rate hikes in 2018, with a possibility of a fourth. As such the period of easy money in the US is over. The same could be happening in the eurozone. Although quantitative easing is still happening in the eurozone, it is likely that it will start tapering off, given the economic growth in the key countries of the eurozone.

There are also indications that the period of exceedingly low inflation is also over. The news about wage increases in the United States, last Monday, seems to have triggered the willingness to sell. Inflation is edging upwards both in the US and in Europe. There was economic growth in all the world’s leading economies. This is not a very common occurrence. Thus financial markets needed to take account of this new scenario.

There is also agreement that certain companies, especially tech companies, are overvalued. Did we have e new bubble in the making? Are investors more wary than they were ten years ago of developing bubbles? If they are, financial markets were due for a correction.

Political instability is another factor to take into consideration. The verbal skirmishes between the president if the United States and the president of North Korea in recent weeks do not help us to sleep peacefully at night. The political uncertainty in a number of European countries (Italy may be totally ungovernable after their election on 4th March) is not helpful either. The form and nature of Brexit is still unknown.

These various considerations lead businesses to reposition themselves. They would not like to go through the horrific nightmare caused by the financial crisis of ten years ago followed by the credit crunch and then followed by an economic recession. I believe that the volatility that we have had in the financial markets this week is a reflection of this need for repositioning.

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