martes, 1 de septiembre de 2015

martes, septiembre 01, 2015
Investing

Market turmoil; the consequences

 by Buttonwood

Aug 29th 2015, 17:49


AUGUST does seem to specialise in episodes of market turmoil, whether one looks back to 2007 (when the subprime crisis really started to bite) or 2011 when the eurozone debt crisis seemed to spread to Spain and Italy. The fact that so many traders and investors are on holiday must make a difference. Liquidity is low; juniors are in charge of investment funds and may be unwilling to act as buyers when prices fall.
 
On return from his holiday, your blogger sees a number of implications of the market move.
 
The fundamental rationale was that markets seemed to catch up with a theme made repeatedly in previous posts; that the slowdown in world trade growth (particularly Asian exports) and falling commodity prices indicated there was a problem with growth in emerging markets, particularly China.

But many investors will have been struck by the sheer ferocity of this week's moves, which saw the Dow Jones Industrial Average open more than 1,000 points lower on Monday and blue chips like GE and Pepsi fall more than 20% at this stage. Some were reminded of the flash crash of 2010, when markets fell inexplicably in minutes (at least this time, there was a plausible explanation.) One reason for the turmoil is the effect of algorithmic trading, computer programmes that can feed on each other (or simply get switched off) in times of crisis. Such traders effectively act as market-makers at normal times, replacing the banks that used to play the dominant role. (The banks now face capital and regulatory constraints on their trading.)
 
Sure enough, the Vix, a standard measure of market volatility, has risen sharply. One could argue that investors should take account of the dangers of these sharp market falls by demanding a higher return (or in other words, only be willing to buy shares on a lower valuation.) But a lower valuation relative to what? Corporate bond markets also suffer from lesser liquidity and government bond markets have had their own abrupt moves (look at German bunds earlier this year). 
 
Indeed, equity markets have been quite calm in recent years, as the Vix shows.



The typical retail investor, making a monthly investment into his or her 401 (k), ought not to worry about a violent one-day move nor should a pension fund or an endowment. One would need to see a much more prolonged period of volatility to make investors reconsider the risk premium they expect.

What pension funds and endowments ought to worry about is the general pattern of investment returns. As our table shows, as of Wednesday night, returns had been negative this year in the US, Britain, Canada, emerging markets and the MSCI world index. Diversifying into bonds didn't help (global returns were negative). The same is true for hedge funds and of course, commodities.
 
So where are the 7.5-8% returns going to come from that US pension funds rely on? A slow-growth, low-inflation world just cannot generate that kind of nominal return. Equity investors have been sheltered by the strength of US corporate profits through the crisis, a phenomenon in part due to weak wage pressures and in part down to global strength; both factors may be fading.
 
This week's turmoil is a wake-up call for funds that have unrealistic return expectations. Time for them to reassess and start making bigger pension contributions. There are other implications for markets, notably the role of central banks, but that will await another blog.

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