EARLIER this year, it all seemed so straightforward, said the Financial Times: "central banks printed money and proffered soothing words and markets went up". Now it's getting a lot more complicated. Hints from the US Federal Reserve that it is mulling a slowing of quantitative easing have combined with "doubts about China's ability to avoid an economic hard landing" and confusion about the impact of Japanese 'Abenomics' to produce a noxious brew of fear and uncertainty. As Nicholas Gartside of JPMorgan Asset Management observed: "It's been fairly violent and extreme." Stocks and bonds across the world suffered another fierce sell-off this week, amid wild gyrations in currency markets. Some of the worst collateral damage was inflicted on emerging market assets in Asia and Latin America – usually the first to be jettisoned when investors start worrying about risk.
The Indian rupee hit a record low against the US dollar; the South African rand plumbed levels not seen for four years; and Brazilian shares are now officially in bear market territory (defined as a fall of 20 per cent or more over a two-month period). The bears are also prowling in Japan, said Michael Stothard and Josh Noble in the FT. After its stellar rise upwards earlier this year, the Nikkei is down 22 per cent from its peak in May: traders fear that the Bank of Japan, which promised to double the monetary base over two years, may not be putting its money where its mouth is. "Hedge funds in particular have been cutting their long Japanese equity positions and short yen positions built up over the past few months." "Could this be the big one," asked Allister Heath of City AM. "The start of a massive, seismic shift in the financial markets" as the era of easy money ends? It's too soon to tell. But we certainly had it coming. Bond markets in particular remain "almost laughably over-valued". A 1990s-style bond market crash is inevitable. "The good news is that we may finally be nearing the moment of truth when markets start to return to their senses. The bad news is that the transition will be hugely painful." Some are certainly steeling themselves for a long ride down. "This will not be a short-lived sell-off," predicted Benoit Anne of SocGen. Still, many in the market take a less apocalyptic view, said Ali Hussain in The Sunday Times. Both Citigroup and Credit Suisse are urging investors to "exploit the spring correction". The latter expects a 15-20 per cent increase in developed market shares over the next two years; and has revised up its end-of-year target for the FTSE 100 (which fell below 6,300 this week) to 7,100. The worries may certainly be overdone – particularly in emerging markets, "which still offer faster growth than the rich world", said Buttonwood in The Economist. "Just as investors often become over-enthusiastic during booms, they can get too depressed in bear markets." At present, emerging-market shares trade at a 25 per cent discount to their developed market peers. "They have been cheaper in the past, but a further period of under-performance will make them very attractive to long-term investors." The falls on the FTSE are "less fundamentals-driven and more people taking money out of the market" because there isn't "enough good news to support valuations going into the quiet part of the year", Matt Basi of CMC Markets told Citywire. These profit-takers may well be back. But there's a danger of a chicken-and-egg situation developing. As one analyst noted: "Volatile markets keep buyers away and the absence of buyers leads to market volatility. We're trapped in a negative spiral right now."
This article appears in the 14 June 2013 edition of The Week. ·