Over 2015 quarter 3, stock markets around the world have seen their biggest falls for four years. As the BBC article states: ‘the numbers for the major markets from July to September make for sobering reading’.
• US Dow Jones: –7.9%
• UK FTSE 100: –7.04%
• Germany Dax: –11.74%
• Japan Nikkei: –14.47%
• Shanghai Composite: –24.69%
So can these falls be fully explained by the underlying economic situation or is there an element of over-correction, driven by pessimism? And, if so, will markets bounce back somewhat? Indeed, from 30 September to 2 October, markets did experience a rally. For example, the FTSE 100 rose from a low of 5877 on 29 September to close at 6130 on 3 October (a rise of 4.3%). But is this what is known as a ‘dead cat bounce’, which will see markets fall back again as pessimism once more takes hold?
As far as the global economic scenario is concerned, things have definitely darkened in the past few months. As Christine Lagarde, Managing Director of the IMF, said in an address in Washington ahead of the release of the IMF’s 6-monthly, World Economic Outlook:
I am concerned about the state of global affairs. The refugee influx into Europe is the latest symptom of sharp political and economic tensions 
in North Africa and the Middle East. While this refugee crisis captures media attention in the advanced economies, it is by no means an isolated event. Conflicts are raging in many other parts of the world, too, and there are close to 60 million displaced people worldwide.
Let us also not forget that the year 2015 is on course to be the hottest year on record, with an extremely strong El Niño that has spawned weather-related calamities in the Pacific.
On the economic front, there is also reason to be concerned. The prospect of rising interest rates in the United States and China’s slowdown are contributing to uncertainty and higher market volatility. There has been a sharp deceleration in the growth of global trade. And the rapid drop in commodity prices is posing problems for resource-based economies.
Words such as these are bound to fuel an atmosphere of pessimism. Emerging economies are expected to see slowing economic growth for the fifth year in succession. 
And financial stability is still not yet assured despite efforts to repair balance sheets following the financial crash of 2008/9.
But as far as stock markets are concerned, the ECB is in the process of a massive quantitative easing programme, which will boost asset prices, and Japan looks as if it too will embark on a further round of QE. Interest rates remain very low, and, as we discussed in the blog Down down deeper and down, or a new Status Quo?, some central banks now have negative rates of interest. This makes shares relatively attractive for savers, so long as it is believed that they will rise over the medium term.
Then there is the question of speculation. The falls were partly due to people anticipating that share prices would fall. But has this led to overshooting, with prices set to rise again? Or, will pessimism set in once more as people become even gloomier about the world economy? If only I had a crystal ball!
Articles
Markets see their worst quarter in four years BBC News (1/10/15)
Weak Jobs Data Can’t Keep U.S. Stocks Down Wall Street Journal, Corrie Driebusch (2/10/15)
What the 3rd Quarter Tells Us About The Stock Market In October EFT Trends, Gary Gordon (2/10/15)
The bull market ahead: Why shares should make 6.7pc a year until 2025 The Telegraph, Kyle Caldwell (5/9/15)
Is the FTSE 100’s six year run at an end? The bull and bear points The Telegraph, Kyle Caldwell (24/8/15)
Webcasts
The stock market bull may not be dead yet CNNMoney (29/9/15)
IMF’s Lagarde: More volatility likely for emerging markets CNBC, Everett Rosenfeld (30/9/15)
What’s next for stocks after worst quarter in four year CNBC, Patti Domm (30/9/15)
Global markets to log worst quarter since 2011 CNBC, Nyshka Chandran (30/9/15)
Speech
Managing the Transition to a Healthier Global Economy IMF, Christine Lagarde (30/9/15)
Questions
- Distinguish between stabilising and destabilising speculation. Is it typical over a period of time that you will get both? Explain.
- What is meant by a ‘dead cat bounce’? How would you set about identifying whether a given rally was such a phenomenon?
- Examine the relationship between the state (and anticipated state) of the global economy and share prices.
- What is meant by (a) the dividend yield on a share; (b) the price/earnings ratio of a share? Investigate what has been happening to dividend yields and price/earnings ratios over the past few months. What is the relationship between dividend yields and share prices?
- Distinguish between bull and bear markets.
- What factors are likely to drive share prices (a) higher; (b) lower?
- Is now the time for investors to buy shares?
Many Chinese people have taken to investing on the Chinese stock market, seeing it as a way of making a lot of money quickly. From October 2014 to June this year the market soared, rising by 126% from 2290 to 5166.
More and more people used their savings to buy stocks and China now has over 90 million individual investors. And it was not just savings that were invested. Increasingly people have been borrowing money to invest, seeing it as an easy way of making money. Unlike stock markets in developed countries, where the majority of shares are held by financial organisations, such as pension funds, holdings by individuals account for about 80% of stocks on the Chinese market.
But since mid-June, share prices have plummeted by 32% (see chart). People have thus seen a huge fall in the value of their savings, while many others have found their shareholdings worth less than their debts. The fall, like the rise that preceded it, has been driven by speculation, fuelled by first optimism and then pessimism.
The Chinese government is worried that the fall might dampen investment and economic growth. It has thus has been supplying liquidity to various institutions to buy shares, but this has had little effect and is dismissed by many as meddling. What is more it could expose companies which take advantage of the liquidity to greater risk.
So serious has been the rout, that over 50% of listed companies have halted trading on the mainland Chinese stock exchanges.
So just why has there been this bubble and why has it burst? What implications will it have for (a) China and (b) the rest of the world? The following articles explore the issues.
China’s stock market fall hits small investors BBC News Magazine, John Sudworth (7/7/15)
China Stocks Plunge as State Support Fails to Revive Confidence Bloomberg (8/7/15)
Chinese stocks are crashing Business Insider UK, Myles Udland, David Scutt (8/7/15)
Shanghai stocks plunge, over 1,200 Chinese companies halt trading Economic Times of India (8/7/15)
Everyone freaking out about China’s stock-market crash is missing one thing Business Insider UK, Elena Holodny (7/7/15)
China’s stock market has lost nearly a third of its value in a month Vox, Timothy B. Lee (8/7/15)
Chinese leaders may be undermined as investors suffer stock market slide The Guardian, Emma Graham-Harrison (8/7/15)
Opinion: China’s stock-market crash is just beginning MarketWatch, Howard Gold (8/7/15)
What does China’s stock market crash tell us? BBC News (22/7/15)
Questions
- What is meant by a ‘bubble’? Has the recent performance of the Shanghai Stock Market been an example of a bubble?
- Is the current fall in share prices in China an example of overshooting? Explain how you would decide.
- Distinguish between stabilising and destabilising speculation. Why does destabilising speculation not go on for ever?
- What is meant by the ‘stock market wealth effect’? How is the fall in the Chinese stock market likely to affect consumption and investment in China? How does the proportion of assets held in the form of shares affect the magnitude of the effect?
- What are the likely implications of the fall in the Chinese stock market for the rest of the world?
- Why has the Hong Kong stock market not behaved in the same way as the Shanghai market?
- What have the Chinese authorities been doing to arrest the fall in share prices? How likely are they to succeed?
With worries about Greek exit from the eurozone, with the unlikelihood of further quantitative easing in the USA and the UK, with interest rates likely to rise in the medium term, and with Chinese growth predicted to be more moderate, many market analysts are forecasting that stock markets are likely to fall in the near future. Indeed, markets are already down over the past few weeks. Since late April/early May, the FTSE is down 4.5%; the German DAX index is down 7.0%; the French CAC40 index is down 6.9%; and the US Dow Jones index is down 2.3%. But does this give us an indication of what is likely to happen over the coming months?
If stock markets were perfectly efficient, then all possible information about the future will already have been taken into account and will all be reflected in current share prices. It would be impossible to ‘get ahead of the game’.
It is only if market participants have imperfect information and if you have better information than other people that you can are likely to predict correctly what will happen. Even then, the markets might be buffeted by random and hence unpredictable shocks.
Some people correctly predicted things in the past: such as crashes or booms. But in many cases, this was luck and their subsequent predictions have proved to be wrong. When financial advisers or newspaper columnists give advice, they are often wrong. If they were reliably right, then people would follow their advice and markets would rapidly adjust to their predictions.
If Greece were definitely to exit the euro, if interest rates were definitely to rise in the near future, if it became generally believed that stock markets were overvalued, then stock markets would probably fall. But these things may not happen. After all, people have been predicting a rise in interest rates from their ultra-low levels for many months – and it hasn’t happened yet, and may not happen for some time to come – but it may!
If you want to buy shares, you might just as well buy them at random – or randomly sell any you already have. As Tetlock says, quoted in the Nasdaq article:
“Even the most astute observers will fail to outperform random prediction generators – the functional equivalent of dart-throwing chimps.”
And yet, people do believe that they can predict what is going to happen to stock markets – if not precisely, then at least roughly. Are they deluded, or can looking calmly at likely political and economic events put them one step ahead of other people who perhaps behave more reactively and emotionally?
Bond rout spells disaster for stock markets as global credit kraken awakens The Telegraph, John Ficenec (14/6/15)
Comment: Many imponderables for markets The Scotsman, Bill Jamieson (14/6/15)
How Ignoring Stock Market Forecasts Will make you a better investor Forbes, Ky Trang Ho (6/6/15)
The Predictions Racket Nasdaq, AdviceIQ, Jason Lina (21/5/15)
Questions
- Why may a return of rising interest rates lead to a ‘meltdown in equity prices’? Why might it not?
- Why have bond yields fallen dramatically since 2008?
- Why are bond yields rising again now and what significance might this have (or have had) for equity markets?
- Why may following the crowd often lead to buying high and selling low?
- Is there an asymmetry between buying and selling behaviour in stock markets?
- Will ignoring stock market forecasts make people better investors?
- “The stock market prices suggest that investors believe both the Federal Reserve and the Bank of England are bluffing about raising interest rates. That may be so, but it is an extremely risky game of chicken for investors to play.” Explain and discuss.
New Look was founded in 1969 and is an iconic budget retailer found on most British high streets. In its history, it has been a family business; it has been listed on the London stock exchange; returned to a private company and then had the potential to be re-listed. Now, it is moving into South African ownership for £780 million.
90% of New Look will now be owned by Christo Wiese who controls Brait and who has been linked with other take-overs of British retailers in recent years. The remaining 10% will remain in the hands of the founding family. The company has been struggling for some time and in 2010 did have plans to relist the company on the London Stock Exchange. However, volatile market conditions meant that this never occurred and the two private equity firms, Apax and Permira, appeared very eager to sell. New Look’s Chairman, Paul Mason, said:
“This is an ideal outcome for New Look. The Brait team demonstrated to us that they have the long-term vision to help Anders and the team grow this brand.”
It is not yet clear what this move will mean for the retailer, New Look, but with an estimated £1 billion debt, it is expected that changes will have to be made. 
It is certainly an attractive investment opportunity and New Look does have a history of high rates of growth, despite its current debt. Furthermore, the debt levels are likely to have helped Mr. Wiese obtain a deal for New Look. Fashion retailing is a highly competitive market, but demand always appears to be growing. It is still relatively ‘new’ news, so we will have to wait to see what this means for the number of stores we see on the high streets and the number of jobs lost or created. The following articles consider this new New Look.
South African tycoon buys New Look fashion retailer BBC News (15/5/15)
South African tycoon enters UK retail fray with New Look purchase Financial Times, Andrea Felsted, Clare Barrett and Joseph Cotterill (15/5/15)
New Look snapped up by South African tycoon The Guardian, Sean Farrell (15/5/15)
New Look sold to South African billionaire for £780m The Telegraph, Elizabeth Anderson and Andrew Trotman (15/5/15)
Questions
- Why might a company become listed on the London stock exchange?
- How would volatile economic circumstances affect a company’s decision to become listed on the stock market?
- What do you think this purchase will mean for the number of New Look stores on British high streets? Do you think there will be job losses or jobs created by this purchase?
- How do you think the level of New Look’s debt affected Christo Wiese’s decision to purchase New Look?
- Which factors are likely to affect a firm’s decision to take-over or purchase another firm?
Many UK coal mines closed in the 1970s and 80s. Coal extraction was too expensive in the UK to compete with cheap imported coal and many consumers were switching away from coal to cleaner fuels. Today many shale oil producers in the USA are finding that extraction has become unprofitable with oil prices having fallen by some 50% since mid-2014 (see A crude indicator of the economy (Part 2) and The price of oil in 2015 and beyond). So is it a bad idea to invest in fossil fuel production? Could such assets become unusable – what is known as ‘stranded assets‘?
In a speech on 3 March 2015, Confronting the challenges of tomorrow’s world, delivered at an insurance conference, Paul Fisher, Deputy Governor of the Bank of England, warned that a switch to both renewable sources of energy and actions to save energy could hit investors in fossil fuel companies.
‘One live risk right now is of insurers investing in assets that could be left ‘stranded’ by policy changes which limit the use of fossil fuels. As the world increasingly limits carbon emissions, and moves to alternative energy sources, investments in fossil fuels and related technologies – a growing financial market in recent decades – may take a huge hit. There are already a few specific examples of this having happened.
… As the world increasingly limits carbon emissions, and moves to alternative energy sources, investments in fossil fuels and related technologies – a growing financial market in recent decades – may take a huge hit. There are already a few specific examples of this having happened.’
Much of the known reserves of fossil fuels could not be used if climate change targets are to be met. And investment in the search for new reserves would be of little value unless they were very cheap to extract. But will climate change targets be met? 
That is hard to predict and depends on international political agreements and implementation, combined with technological developments in fields such as clean-burn technologies, carbon capture and renewable energy. The scale of these developments is uncertain. As Paul Fisher said in his speech:
‘Tomorrow’s world inevitably brings change. Some changes can be forecast, or guessed by extrapolating from what we know today. But there are, inevitably, the unknown unknowns which will help shape the future. … As an ex-forecaster I can tell you confidently that the only thing we can be certain of is that there will be changes that no one will predict.’
The following articles look at the speech and at the financial risks of fossil fuel investment. The Guardian article also provides links to some useful resources.
Articles
Bank of England warns of huge financial risk from fossil fuel investments The Guardian, Damian Carrington (3/3/15)
PRA warns insurers on fossil fuel assets Insurance Asset Risk (3/3/15)
Energy trends changing investment dynamics UPI, Daniel J. Graeber (3/3/15)
Speech
Confronting the challenges of tomorrow’s world Bank of England, Paul Fisher (3/3/15)
Questions
- What factors are taken into account by investors in fossil fuel assets?
- Why might a power station become a ‘stranded asset’?
- How is game theory relevant in understanding the process of climate change negotiations and the outcomes of such negotiations?
- What social functions are filled by insurance?
- Why does climate change impact on insurers on both sides of their balance sheets?
- What is the Prudential Regulation Authority (PRA)? What is its purpose?
- Explain what is meant by ‘unknown unknowns’. How do they differ from ‘known unknowns’?
- How do the arguments in the article and the speech relate to the controversy about investing in fracking in the UK?
- Explain and comment on the statement by World Bank President, Jim Yong Kim, that sooner rather than later, financial regulators must address the systemic risk associated with carbon-intensive activities in their economies.
Over 2015 quarter 3, stock markets around the world have seen their biggest falls for four years. As the BBC article states: ‘the numbers for the major markets from July to September make for sobering reading’.
And financial stability is still not yet assured despite efforts to repair balance sheets following the financial crash of 2008/9.
