Over the past month or so we have seen an increase in the levels of volatility in world markets. Initially this was caused by a sharp sell-off in the mainland Chinese market. Within the period of February 26th to March 5th, the FTSE China index, in sterling terms, fell 11.4%. However, this did follow a gain of 13% in the previous six trading sessions with the falls being attributed to fears that the Chinese authorities were planning to cool down the excesses in the market in an attempt to moderate growth to more sustainable and realistic levels.
The falls in the Chinese market, the market where many commentators are suggesting that investors could expect to see significant growth over the coming years, triggered a sell off in the major world markets. February 26th saw the US stock indices suffer their heaviest falls since 11th September 2001, while the UK market incurred its biggest drop since June of last year and the European bourses saw similar declines.
While the falls were originally blamed on the decline in the Chinese market, the actual correlation between this market and other global equity markets is in fact quite low. This was demonstrated by the subsequent prompt recovery that the Chinese market experienced which was not replicated with such speed elsewhere.
Concerns over the US economy were, in fact, the main reason for the recent market sell-off outside of China.
Initially, we saw weaker than expected US durable goods orders while sentiment was also not helped by a comment from the former US Federal Reserve Chairman, Alan Greenspan, which warned of a likely US recession. The US recession headline was somewhat misleading as he only said that there was a possibility of a recession but forecasting one was difficult - evidence indeed that despite handing over the Fed's reins to Ben Bernanke, investors still listen when Greenspan speaks.
There was also a significant level of concern regarding the sub-prime mortgage market in the US.
Sub-prime lending is the area of the market available to investors who typically have a low-credit rating and are responsible for approximately 10% of US consumer spending with borrowers having to pay higher rates of interest to compensate for the additional rate of default. The announcement that a record number of these types of mortgages were entering delinquency coupled with poor US retail sales figures pushed the market down.
Apart from the US economy, the other major concern is the potential unwinding of the "carry-trade" in the Yen. The carry-trade is the practice of borrowing in low-yielding currencies, such as the Yen, to invest in higher-return assets. Investment in carry-trades has been wide spread in recent months and if there was for example a 10% rise in the Yen, it could lead to a further sell-off in a range of assets.
Notwithstanding the above issues, it is widely believed that the markets were taking an overdue breather following significant gains since June last year.
At Origen, we anticipate short-term movements in equity markets are likely to remain volatile over the coming months. However, we continue to believe that the medium to long-term outlook for equities remains strong, particularly with the continuation of the existing high levels of corporate activity.
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