Rescuing the rescuers
Having saved the banks, governments now find themselves under the wary eye of the markets
May 27th 2010
IF BULLISH investors had been given two Christmas wishes at the end of 2009, they probably would have asked for booming profits and a continuation of ultra-lowinterest rates. Their wishes have been granted. According to Morgan Stanley, the first-quarter profits of companies in the S&P 500 have been more than 12% better than expected. Meanwhile, few expect the Federal Reserve, the European Central Bank (ECB) or the Bank of England to raise rates this year. Some think rates will stay where they are in 2011, too.
So why is the MSCI World index of globalequities down by more than 10% this year, with emerging markets showing double-digit losses and European bourses shedding more than 20% in dollar terms? On May 25th the FTSE 100 index closed below 5,000 for the first time since last October. The next day the Dow Jones Industrial Average closed below 10,000 for the first time since February.
This latest setback may simply be a reaction to thephenomenal rally that has taken place since March 2009. Back then, fears of a second Depression were widespread. As confidence returned, the S&P 500 index jumped by 80% to its most recent high in late April. Eventually, all the good news was priced in and there were signs of complacency: in early May a survey by Investors Intelligence, a research firm, found that three times as many Americanfinancial advisers were bulls (54%) as were bears (18%).
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May has seen the re-emergence of a number of worries that had been beneath the surface. The latest is geopolitical risk, in the specific form of rising tension in theKorean peninsula. Reports that Kim Jong Il, the North Korean dictator, had placed his forces on a war footing caused Asian markets to fall sharply on May 25th. The erratic actions of North Korea, a country with too many weapons and not enough food, are akin to Middle East politics: a wild card that can occasionally upset investors.
However, investors’ biggest financial concern is sovereign debt,notably that of some southern European countries. In recent weeks the European Union has been forced both to rescue Greece and to unveil a general bail-out package, worth up to €750 billion ($920 billion) including a contribution from the IMF, for struggling countries. Investors seem to be in two minds on sovereign debt. They worry that individual countries may default if they do not cut their deficitsand that banks holding their debt will be clobbered. They think that Greece’s debt crisis has been postponed rather than solved. But investors are also concerned that, if several governments try to tighten fiscal policy at once, the global economy will take a hit.
Europe is expected to experience sluggish growth in the medium term as it struggles with its debts. But in recent weeks worries havealso emerged about growth in Asia and America. In Asia, the question is whether China’s attempts to rein in its housing market will prompt a broader slowdown (see article). In America, momentum seems to have faded a little after a strong performance in the last quarter of 2009. Some data, such as initial jobless claims and the Conference Board leading indicator, have been disappointing.
All thishas led to a sell-off of the “risk basket”—those assets that seem most correlated with global growth, such as the Australian dollar, copper and emerging-market equities (see chart 1). Oil has been another casualty, with crude prices falling by around 20% in May alone. This week the price of a barrel dipped below $70. Investors have headed away from risk, flocking into the bonds of what they...