Tags: sotck market | federal reserve | optimism | investor

Stock-Market Optimists Face a Big Challenge

By    |   Monday, 13 October 2014 11:14 AM

Stock markets are in the news again, thanks to their increasingly volatile behavior.

Last week, the Dow Jones Industrial Average logged its largest single-day decline this year, a day after rising more than 250 points. The cumulative daily moves, in both directions, have exceeded 2,000 points so far this month, more than 10 percent of the value of the index.

Overall, the trend has been down, eroding much of the gain investors had enjoyed this year.

The return of volatility shouldn’t come as a huge surprise. What's really surprising is that central bankers, without the help of government policy makers, managed to deliver such a long period of calm in financial markets. In doing so, they helped push stock and bond prices to levels well in excess of what the economic fundamentals could justify.

Lately, though, central bankers' levitation of markets has run into some challenges. The International Monetary Fund again revised downward its projections of global economic growth. Germany, Europe's economic powerhouse, reported a sharp contraction in industrial production. Commodity markets, which central banks cannot easily influence, have plunged a lot more than stocks. Even dovish remarks from officials at the Federal Reserve and the European Central Bank haven’t been enough to offset the gloom, at least so far.

To keep asset prices up and to restore durable calm in this environment, central bankers need help from two sources. The first is a host of government agencies that, together, have much better instruments to address what IMF Managing Director Christine Lagarde has called the “new mediocre” for the global economy. Second, they need investors to keep putting money into the market — particularly those with a lot of cash on the sidelines and willing to stick to their “buy on dips” strategy.

There is little reason for optimism on the first source. As the weekend's meeting of the IMF and World Bank demonstrated, there's still not enough agreement on what ails the global economy or what needs to be done, let alone the political will to do it.

The second source is in place but it can no longer be taken for granted. The relatively positive outlook for the U.S. economy, together with a further decline in interest rates that has seen increasingly negative yields on German government bonds, will encourage investors to deploy excess cash. Yet there willingness to keep doing so depends in part on market volatility: The longer the volatility persists, the less will be their eagerness to put more funds at risk.

Given recent experience, it's understandable that so many investors have faith in the ability of central banks to restore market calm. Still, there's a limit to how long these institutions, acting essentially on their own, can keep asset prices inflated in the context of a weakening global economy and concerns about the effectiveness of their policies.

Although they may not realize it fully, optimistic investors are increasingly betting that their elected representatives in government will step in with the infrastructure investment and deeper reforms needed to reinvigorate the recovery. This is much more of a hope than a sure thing.

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Stock markets are in the news again, thanks to their increasingly volatile behavior.
sotck market, federal reserve, optimism, investor
Monday, 13 October 2014 11:14 AM
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