Global markets searching for long-term stability
Some commentators have rushed to describe the recent global stock market turmoil as “historic” and “unprecedented,” yet its evolution has been quite traditional so far.
What may be different this time, however, is whether longer-term stability can be restored with the policy tools that were available in the past.
This selloff started as a repricing of global growth prospects. Mounting evidence of economic weakness in the emerging world, along with persistent low growth in Europe and Japan, made it hard for markets to ignore the impact on earnings and profitability of a global slowdown.
The selloff accelerated as fears spread that policy makers may not be able to respond sufficiently quickly and effectively. Part of this worry had to do with the extent to which central banks have depleted their ammunition stores after years of carrying the bulk of the policy burden. But a more significant concern arose from the correct realisation that the primary response would have to come from the emerging economies that are the source of the growth and financial concerns this time, and not from the Federal Reserve and the European Central Bank.
As is often the case, the selloff further gathered steam when traders realised that policy circuit breakers would not materialise immediately. The rout became disorderly for a short while when classic deleveraging technical forces, including forced generalised selling by volatility-sensitive investors and over-extended portfolios, took hold of the markets. The result was the conventional mix of price air pockets, valuation overshoots and contagion.
Those are the typical stages of a generalised market selloff. This cycle exhausts itself once prices come down sufficiently to create compelling bargains for sidelined investible funds. This tends to happen first for the best managed companies with resilient balance sheets, and then it spreads to the market as a whole. And there is a lot of dry powder out there, including cash in the hands of households and companies that can be deployed in investment purchases and stock buybacks, or funds parked in bonds whose yields have fallen and that will look for higher-return opportunities.
Longer-term asset price stabilisation could also come from a reinforcement of the markets’ economic and policy underpinning. But with economic growth consistently failing to take off, this responsibility has fallen in the recent past mainly to central banks, led by the Fed and the ECB — the system’s traditional core. This time, however, genuine and durable stabilisation will require that a good part of the solution come from the emerging world.
Given the economic and political challenges in many of the systemically important emerging economies, it will take time for growth to come back strongly and for comprehensive policy solutions to emerge. These could include the deepening of structural reforms, the rebalancing of aggregate demand or the lifting of pockets of overleverage and over-indebtedness.
As a result, the best that can be hoped for right now is short-term market stabilisation through another series of liquidity-driven Band Aids. This approach would provide much appreciated immediate relief; but it wouldn’t be sufficient to deliver the longerterm anchor of stability that the global financial system is searching for.