Tuesday, 16 August 2011

It is tough to be a stock market dealer

Among bond dealers, it is a well-known fact that the stock markets cannot concentrate on more than one thing at a time. So it must be tough to be a stock dealer or advisor these days. There are so many things to worry about.

Maybe one should not be too tough on the market participants when they are being interviewed for TV or press. With a significant slowdown looming, downgrades falling hard and fast and something wrong in the Euro-zone, it really is possible to be quite confused.

Stock markets tell us that the S&P downgrade of the US Treasuries ushered in a period of grave turmoil in the stock markets and that further debt trouble in Europe makes it worse. One more downgrade would bring more chaos. So how come that those incompetent politicians are just sitting on their hands instead of doing something??

Please! Let us try and go as far back as to 1 August. Europe had just announced a clever Greek restructuring plan that avoided what everybody feared, a default event. Italy had approved a significant program to cut its government deficit. In the US, the debt ceiling had just been lifted after weeks of undignified brinkmanship. That should be what every stock market would need to create a solid rally.

In the event, the opposite happened. The bond markets had already given clear indications months in advance: Economic growth had shifted down a gear or two. Suddenly the stock markets began to fall on fears of a recession that would for sure hit company earnings. Pure logic, except one could speculate why the stock markets’ Wile E Coyote moment had lasted that long.

And then S&P announced its downgrade. Since that moment stock markets have traded sideways under high volatility. Bond yields have fallen as more evidence of the economic slowdown came in. In other words, there has been NO effect of the S&P downgrade.

But since the economic slowdown was now sort of old news, the stock markets had to find something to rationalise the palpable fear. Maybe France will lose her AAA-rating (quickly denied in unison by the tree big ratings agencies)? Maybe Italy will collapse (with a government debt at the same level as 8 years ago)? Maybe Spain may not be able to cut it (with a budget deficit and a government debt lower than that of the USA)? The Euro, then? Will it collapse (it has traded in a narrow range over the past weeks)?

Everywhere we look, things look pretty much the same as they did 4 months ago. Some uncertainties have been removed (the Greek restructuring) and some new uncertainties have appeared (the slower growth worldwide). For investors with a longer memory than 2 market days, it is obvious that the moment where the stock market discovered the slower growth, something was bound to happen.

It is particularly interesting to hear market participants now quickly turning into experts on German domestic politics. They are now looking for shards of evidence that Chancellor Merkel may throw overboard well-established (and healthy) policy principles in order to calm the nerves of stock market participants who have already forgotten everything that has happened over the past month.

I am not trying to say that everything is OK. Even if I disagree with the sometimes brutal austerity programmes and believe they will cost economic growth in the future, a lot of things are being done in Europe to fix the situation.

Unfortunately, structural problems in the Eurozone cannot be fixed within a 24-hour news cycle. Germany will eventually cave in to Eurozone bonds. But only after a revision of the EU Treaty that gives real teeth to a European fiscal authority and only after several countries have had the time to amend their constitutions in order to implement the new treaty in local legislation. That will not happen anytime soon.

We will hear more nonsense from the stock markets. The best antidote is to try and keep the focus on what is the real driver of events: it’s the economy, stupid.

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