Financial Times Editorial - Editorial comment: timely reminder about risk
Financial Times Editorial - Editorial comment: timely reminder about risk
Copyright The Financial Times Limited 2007
Published: March 2 2007 23:15 | Last updated: March 2 2007 23:15
Whenever a new outbreak of avian flu is reported people eat less chicken, not just from the infected farm, but from anywhere. They clearly feel they have learned something new and nasty about chicken, and that it has become riskier, even if the chickens themselves are the same, somewhat confused-looking birds that they were before. This week something similar happened in the world’s investment markets.
The price of almost every risky asset fell, almost everywhere in the world, with most big stock markets down by 4-6 per cent. Yields on government bonds went down, yields on corporate and high-yield bonds, which carry greater credit risk, went up. Currencies with low interest rates, such as the Swiss franc and Japanese yen, rose and volatility increased all round.
Traders, who never go short of explanations, had various theories to explain the fall. It was whispers in China, where markets started dropping first, about restrictions on speculative trading. Or it was an unexpectedly large fall in US orders for durable goods such as machinery. Or it was comments by Alan Greenspan, former governor of the Federal Reserve. All of these events happened at the same time as the market falls but none contains enough new information to explain them properly.
Whatever the cause, after a start to the year when markets rose, there was a reaction against risk. Investors got a reminder that markets can go down as well as up and cut their exposure.
It is both interesting and important that so many markets moved together. It is a reminder that, in a correction and especially in a crisis, apparently unrelated assets suddenly start to do similar things: portfolios that look diversified may not be. These correlations seem to exist even without direct links between markets: traders do not seem to have sold American stocks in order to fund their losses in Shanghai.
The question, as it always is, is what happens next: is this a bout of nerves or the beginning of a slump? The answer, as it always is, is that nobody really knows. But unlike other bear markets in recent years – in 1987, for example, or when the internet bubble burst in 2000 – equities are not trading a long way out of line with profits.
The world economy is growing fast and, on the data we have so far, a US recession in 2007 looks unlikely. Profits are taking a record share of output in many countries, which supports share valuations. The markets that do look frothy are corporate debt, especially that of highly leveraged companies, emerging market bonds, and property in countries like the UK and Spain.
Investors have been buying some of these assets at prices that leave almost no premium for risk. If the events of this week encourage greater circumspection then this will have been a bout of market turmoil well worth enduring. As with avian flu, it is better to slaughter a farm-full of chickens now than to risk an epidemic later.
Copyright The Financial Times Limited 2007
Published: March 2 2007 23:15 | Last updated: March 2 2007 23:15
Whenever a new outbreak of avian flu is reported people eat less chicken, not just from the infected farm, but from anywhere. They clearly feel they have learned something new and nasty about chicken, and that it has become riskier, even if the chickens themselves are the same, somewhat confused-looking birds that they were before. This week something similar happened in the world’s investment markets.
The price of almost every risky asset fell, almost everywhere in the world, with most big stock markets down by 4-6 per cent. Yields on government bonds went down, yields on corporate and high-yield bonds, which carry greater credit risk, went up. Currencies with low interest rates, such as the Swiss franc and Japanese yen, rose and volatility increased all round.
Traders, who never go short of explanations, had various theories to explain the fall. It was whispers in China, where markets started dropping first, about restrictions on speculative trading. Or it was an unexpectedly large fall in US orders for durable goods such as machinery. Or it was comments by Alan Greenspan, former governor of the Federal Reserve. All of these events happened at the same time as the market falls but none contains enough new information to explain them properly.
Whatever the cause, after a start to the year when markets rose, there was a reaction against risk. Investors got a reminder that markets can go down as well as up and cut their exposure.
It is both interesting and important that so many markets moved together. It is a reminder that, in a correction and especially in a crisis, apparently unrelated assets suddenly start to do similar things: portfolios that look diversified may not be. These correlations seem to exist even without direct links between markets: traders do not seem to have sold American stocks in order to fund their losses in Shanghai.
The question, as it always is, is what happens next: is this a bout of nerves or the beginning of a slump? The answer, as it always is, is that nobody really knows. But unlike other bear markets in recent years – in 1987, for example, or when the internet bubble burst in 2000 – equities are not trading a long way out of line with profits.
The world economy is growing fast and, on the data we have so far, a US recession in 2007 looks unlikely. Profits are taking a record share of output in many countries, which supports share valuations. The markets that do look frothy are corporate debt, especially that of highly leveraged companies, emerging market bonds, and property in countries like the UK and Spain.
Investors have been buying some of these assets at prices that leave almost no premium for risk. If the events of this week encourage greater circumspection then this will have been a bout of market turmoil well worth enduring. As with avian flu, it is better to slaughter a farm-full of chickens now than to risk an epidemic later.
posted by Carlos T Mock @ 8:43 AM
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