A wise clerk on the production desk of a national newspaper was ruthless when he saw me appear: “What’s up today, Alex, are the markets up or down?”
I had come to the conclusion that most of the sharp moves in the stock or currency markets tell us very little about the real economy of growth, employment and output.
In fact, highly acclaimed guru Paul Samuelson, author of a landmark economics textbook, quipped: “The stock market has predicted nine of the last five recessions.”
In short, we shouldn’t take big sell-offs too seriously.
So what can we make of the current crisis? It is clear that the magnitude of the declines will be a cause for great concern for those of us who are heavily exposed to equities, either directly or through insurance policies or pensions.
Losses: Investors who have bought stocks on margin (by taking out loans) could find themselves in trouble as brokers make demands for cash.
But this is not 2008, when the global banking system was on the brink of collapse and required a global bailout, nor March 2020, when Covid-19 forced much of the world economy to shut down.
A more relevant comparison is that of 1997, when the United States and Europe were at odds economically. This time, a series of uncoordinated mistakes played a major role.
Japan decided to raise interest rates in an effort to halt the yen’s fall against the dollar, amid a slowdown in rate cuts in Europe, with the UK, eurozone and Switzerland believing the genie of inflation had been killed.
Their out-of-sync moves contributed to the Nikkei’s alarming 12 percent implosion yesterday, its biggest drop since 1987.
The US central bank, the Federal Reserve, has been reluctant to announce an end to inflation and kept its key interest rate at 5.25 percent to 5.5 percent last week.
Just hours later, the latest unemployment figures were seen as evidence – too weak – that the US could be heading for a recession. This is not confirmed by the latest US services sector data, which show that business orders and employment actually improved in July.
Just as critical for the American market was the decision by famous American investor Warren Buffett to halve Berkshire Hathaway’s stake in Apple, thereby increasing its cash holdings to £213 billion.
His decision was seen as a sign that Buffett, 93, is nervous about the valuations of the “Magnificent Seven” technology companies, which together account for nearly a third of the market capitalization of all U.S. stocks.
In 1997, the Fed’s reaction to the market storm was to immediately apply the traditional remedy for crashes, which is to immediately cut interest rates to boost liquidity.
The events of the past few days can only accelerate interest rate cuts in the United States, with some analysts speculating that there will be falls of up to 1.25 percentage points by the end of the year, which would be rapid given the historical circumstances.
Market mechanisms have been strengthened. Circuit breakers have been introduced, designed to stabilise disorderly price movements when equipment is sold.
Bank capital has been strengthened, so that the negative feedback loop from market events to the broader financial system is less pronounced.
However, investors who have bought shares on margin (by borrowing) could find themselves in trouble as brokers make demands for cash.
Personal catastrophes will occur and funds that are too risky will suffer the consequences.
But no one should forget that markets have been on an unprecedented bull run and a correction, particularly in overheated tech stocks, was always possible.
Not long ago Japan was celebrating the fact that its stock markets had finally put the lost decades behind them, so there will be bitter disappointment at the reversal.
There is nothing to suggest that one of the world’s great manufacturing and technology economies has gone off the rails.
For much of this year, global economic watchdogs have hailed the world economy’s “soft landing.” Inflation has been brought down without triggering a deep recession or high unemployment.
There is a lot of political uncertainty.
Donald Trump’s threat of a tariff war with the rest of the world evokes chilling memories of the 1930s.
A widespread conflagration in the Middle East could disrupt energy markets.
These are known unknowns.
It’s time to be brave. Panic selling is not a sensible response.
