"An unending chain of explosions", as Bill Jamieson puts it in Scotland on Sunday, has rocked financial markets. The MSCI World Index of 23 developed countries hit a five-year low early this week before a US-led rebound on Tuesday. This was fuelled by talk of a Japanese rate cut, which lowered the yen and eased concern over the unwinding carry trade. The main US, UK and European indices, down by around 40% this year, are near five-year lows. Emerging-market stocks fell by 15% last week. Currency markets have also been in turmoil.
Selling across all markets has intensified of late as investors have fled risk and unwound carry trades, whereby they borrowed low-yielding yen and parked the money in higher-yielding currencies or risky assets. The acceleration of deleveraging has also meant that hedge funds, partly due to restrictions on short-selling one of their key strategies are increasingly selling off assets to cover redemptions by investors and meet margin calls from lenders. These sales push down asset prices and prompt lenders to demand more collateral from leveraged investors, creating a vicious circle.
Computers are playing a key role here, says Gillian Tett in the Financial Times. Banks often use "value-at-risk" (VaR) models to assess the riskiness of loans made to hedge funds and their own assets. This is gauged by how the asset's market price has moved in the past. The trouble is that over the past few years unusually low volatility "cast a fabulously flattering light" on the risk levels of assets, encouraging massive lending to hedge funds. Now that volatility has made a comeback, VaR models are showing that risk has exploded. So banks are selling assets and slashing loans to hedge funds, triggering fire sales and more volatility. "It's a vicious trap" that has engulfed everything from sterling to Chinese shares.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Underlying all this is that equity investors, "rather slow to respond to events in the past year", as the FT notes, are realising that the economic outlook is grim. Lousy data and the collapse of leading banks are prompting worries that the global downturn could become a depression, says Oliver Kamm in The Times. The unwinding of the debt bubble looks set to cause "enormous amounts" of economic and financial damage, says Jamieson. Britain's third-quarter GDP contraction was worse than expected, suggesting a protracted slowdown is on the cards; JPMorgan's Bruce Kasman is pencilling in a fall in US GDP of 4% in the fourth quarter, the worst since 1982.
More earnings disappointments thus look likely, while a long-term view of valuations also highlights scope for further downside. The so-called Shiller p/e ratio, which averages out earnings over the past decade (thus adjusting for the unusually strong recent profit growth) is at around 14.5 in the US, below the average of 16 since 1881. But the average trough figure in the recessions between 1923 and 2000 was 10.8, as Capital Economics points out and below ten in downturns where the US economy shrank by at least 2.5%, says Edward Chancellor in the FT. Previous nasty bear markets have reduced the UK and European Shiller p/e to single figures. They are now around 12. As Tony Jackson puts it in the FT, "tin hats all round, I fancy".
-
What happens if you can’t pay your tax bill, and what is "Time to Pay"?Millions are due to file their tax return this Friday as the self-assessment deadline closes. Though the nightmare is not over until you pay the taxman what you owe - or face a penalty. But what happens if you can't afford to pay HMRC your tax bill, and what is "Time to Pay"?
-
What does Rachel Reeves’s plan for growth mean for UK investors?Rachel Reeves says she is going “further and faster” to kickstart the UK economy, but investors are unlikely to be persuaded
