‘GLOBAL MARKETS TURN VOLATILE , ‘ by Fidelity Market Analyst at

In Uncategorized on February 12, 2010 at 16:55

Global markets turn volatile


Global financial markets have sputtered out of the gate so far in 2010.

After a nearly 10-month rally at the end of 2009, global stock markets reversed themselves during the first few weeks of the year, with non-U.S. stocks declining roughly 8% through February 7.i  Bonds in several debt-strapped nations, including Greece and Portugal, have sold off as investors demanded higher interest rates amid rising perceived risk. The upswing in many commodity prices (e.g. crude oil and copper) and non-U.S. currencies (e.g. the euro) reversed, with the move away from risky assets benefiting perceived safer assets such as the U.S. dollar and U.S. Treasury bonds.ii

The sources of market volatility are multiple. However, they all stem from what is likely to be a theme throughout 2010—uncertainty regarding how successfully the world can transition from the 2009 post-crisis rebound to a broad-based and self-sustaining economic recovery.

Specifically, two issues are front and center. First, will the inevitable removal of policy stimulus measures, from low interest rates to government spending, be effectively offset by private sector growth? Second, will the aftermath of the crisis, in particular rising government debt levels, short-circuit the world recovery? Until the global economy and financial markets provide demonstrable evidence that a full recovery can take place even as extraordinary government stimulus is removed, the backdrop for asset prices is likely to remain volatile.

Growing sources of concern

Sovereign debt issues in Europe: In the aftermath of the financial crisis and economic downturn, the fiscal positions of several countries around the world have been ravaged by recession-battered tax revenues and the splurge on government stimulus spending.

The highest profile concerns in early 2010 center on the debt problems of a handful of smaller economies in the European currency zone, most notably Greece, Portugal and Spain. As a result of their challenging outlook of sky-high deficits, weak economies and rising debt levels, investors have sold off sovereign bonds and forced up the rate at which the governments can borrow.

Long-term government bond yields have spiked in recent weeks, with Greece and Portugal now paying substantially more to service their debt than their larger, more stable euro neighbors, such as Germany (see Exhibit 1). The cost of insuring against a sovereign default (through the credit default swap market) has risen substantially for Greece and Portugal.iii

These worries have caused a drop in the value of the euro (5% year-to-date vs. the U.S. dollar), broad-based declines in Euro-zone stock prices (13.5% year-to-date), and concerns that one of the more troubled countries will require a bailout from other European nations.iv  They also have led to concerns that sovereign jitters may spread risk aversion to other markets or be followed by wider fiscal problems in larger countries such as the U.K., Japan or the United States.

Fears of China pulling on the reins: China’s rapid re-acceleration of growth in 2009 arguably spurred the end of the global recession as much as any other development, sparking a rebound in commodity prices and a recovery among several of its Asian trading partners.

Because this re-acceleration could be attributed at least in part to significant policy stimulus by the government, early 2010 reports of measures to rein in the stimulus gave rise to investor concerns that officials were moving to put the brakes on the world’s fastest-growing large economy. Chinese officials have reportedly tightened monetary policy by raising the required reserve ratio for banks, as well as issuing guidance for loan growth that would reduce bank lending well below last year’s levels.

These and other actions are likely the beginning of an effort to soak up excess liquidity and rein in portions of the more extraordinary monetary stimulus measures implemented during the past year.

Perspective on recent volatility

Correction was not unexpected: Amid all the anxious 2010 headlines and heightened market volatility, however, it is easy to lose sight of the fact that not everything is universally gloomy.  After all, foreign stock markets rose 72% during the last 10 months of 2009, with emerging-market stocks more than doubling from their March 2009 lows.v  Given these sharp gains in a short period of time, markets were probably due for a pullback at some point.

History shows that maturing bull markets typically give way to more gyrations than during the early stage of a market rebound, so increased volatility in 2010 should not have been unexpected.

Sources of volatility not disastrous: Keep in mind as well that monetary and fiscal policies in most major economies remain strongly supportive, with global policy interest rates at all-time lows. Even China has not yet moved to raise its official borrowing rate, and money growth remains rapid.

Chinese bank loan growth has decelerated from its remarkable pace of early 2009, but it continues to expand at a rapid clip. While China will likely continue to remove some of the extraordinary stimulus it provided in response to the crisis, such developments would appear to be an appropriate response to its high pace of economic growth (10.7% Q4 2009 GDP growth) and a healthy sign that such support is no longer

While borrowing costs have risen for governments of several smaller Euro-zone countries, many of their larger and less debt-challenged European counterparts (such as Germany) have not suffered similar fates. Many larger developing countries, including Brazil and China, continue to experience relatively solid financial profiles and improving investor appetite for their debt. Investors have pared their collective risk appetite early in 2010, but there is not yet evidence of widespread financial contagion.

Economic improvement still the trend: More than anything, it is also important to remember that the trend of broad-based improvement in global economic and corporate fundamentals that began during the second half of 2009 is still largely in place.

Global manufacturing production and trade continue to rebound, while corporate profits continue to recover. The pace of growth in several larger developing economies—including China, India and Brazil—has returned to near pre-recession levels. Leading economic indicators of the world’s largest developed economies, which historically have been strong indicators of near-term economic trends, have continued to show improvement (see Exhibit 1).

The world is clearly not yet out of the woods, but incremental improvement remains the over-arching direction of the global economy.

Investment implications

The dire nature of the 2008 global financial crisis and coinciding economic recession prompted policymakers around the world to provide an unprecedented amount of monetary and fiscal policy stimulus in 2009.

In 2010, the transition to removing that stimulus and the lingering impact of rising government debt levels are likely to provide a more uncertain macroeconomic backdrop for the world’s asset markets.

In today’s global financial markets, uncertainty surrounding Greek government debt or Chinese bank policy can quickly transmit trading volatility throughout the world, as demonstrated by the opening weeks of 2010. The good news is the underlying trend of improvement in global economic and corporate fundamentals still appears on track, even as the path is likely to remain bumpy.


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