What’s going to happen to stock market prices? If we knew that, we could be very rich! Nevertheless, financial analysts constantly try to predict the movements of shares in order to decide when to buy and when to sell. One thing they do is to look at charts of price movements and look for patterns. These ‘chartists’, as they are sometimes called, refer to something known as the ‘death cross’ or ‘dark cross’.
So what is the death cross? Imagine a chart of the movements of share prices, such as the FTSE 100 in the UK or the Dow Jones Industrial Average and S&P 500 in the USA. These movements can be shown as a moving average. In other words, for each day you plot the average of the past so many days. Typically, 200-day (sometimes 100-day) and 50-day moving averages are plotted. The 200-day (or 100-day) is taken as the long-term moving average and the 50-day as the short-term moving average. In a falling market, if the short-term moving average crosses below the long-term moving average, this is called the ‘death cross‘ as it signifies growing downward pressure in the market. The fall in the long-term average in these circumstances will indeed lag behind the fall in the short-term moving average.
Markets around the world are experiencing the death cross. So should be be worried? Or is this like looking for patterns in tea leaves, or the stars, and using them to make bogus predictions? So: science or mumbo jumbo?
First the science: the death cross indicates a fall in confidence. And at present, there is much for investors to worry about. Burgeoning debts, austerity measures and fears of a double-dip recession are spooking markets.
Now the mumbo jumbo. Just because markets are falling at the moment, this does not prove that they will go on falling. Markets are often spooked, only to recover when ‘sanity’ returns. People may soon start to believe that a second credit crunch will not return, given all the regulatory and support measures put in place, the huge amount of liquidity waiting to be invested and the support packages from the ECB and IMF for Greece and, potentially, for other eurozone countries having difficulties servicing their debts. In other words, patterns may repeat themselves, but not necessarily. It depends on circumstances.
Articles
Market’s Swoon Prompts Fears Of the Dreaded ‘Death Cross’ CNBC, Jeff Cox (1/7/10)
Death Cross in S&P 500 May Not Lead to Rout: Technical Analysis Bloomberg Businessweek, Alexis Xydias (30/6/10)
Are the markets about to encounter the”Death Cross”? BBC News, Jamie Robertson (1/7/10)
MarketBeat Q&A: Debunking the ‘Death Cross’ Wall Street Journal blogs, Matt Phillips (30/6/10)
Technical analysis and market data
Moving Average Crossovers TradingDay.com, Alan Farley
Death Cross Investopedia
FTSE 100 historical prices Yahoo Finance
S&P 500 historical prices Yahoo Finance
Dow Jones historical prices Yahoo Finance
Questions
- Explain what is meant by the death cross and use a diagram to illustrate it. What is menat by the golden cross. Again, use a diagram to illustrate it.
- Under what circumstances would speculation against stock market price movements be (a) stabilising and (b) destabilising?
- What is the implication for stock market prices of a ‘wall of money’?
- How much faith should be put in chartist explanations of stock market prices? Do criticisms of chartism apply to all time-series analysis that is used for forecasting?
- Look back at newspaper articles from a year ago and see what they were predicting about stock market prices. Have their preductions been borne out? If so, why? If not, why not?
Keynes referred to the ‘paradox of thrift’ (see, for example, Box 17.5 on page 492 of Sloman and Wride, Economics, 7th edition). The paradox goes something like this: if individuals save more, they will increase their consumption possibilities in the future. If society saves more, however, this may reduce its future income and consumption. Why should this be so? Well, as people in general save more, they will spend less. Firms will thus produce less. What is more, the lower consumption will discourage firms from investing. Thus, through both the multiplier and the accelerator, GDP will fall.
What we have in the paradox of thrift is an example of the ‘fallacy of composition’ (see Sloman and Wride, Box 3.7 on page 84). What applies at the individual level will not necessarily apply at the aggregate level. The paradox of thrift applied in the Great Depression of the 1930s. People cutting back on consumption drove the world economy further into depression.
Turn the clock forward some 80 years. On 26/27 June 2010, leaders of the G20 countries met in Canada to consider, amongst other things, how to protect the global economic recovery while tackling the large public-sector deficits. These deficits have soared as a result of two things: (a) the recession of 2008/9, which reduced tax revenues and resulted in more people claiming benefits, (b) the expansionary fiscal policies adopted to bring countries out of recession.
But the leaders were divided on how much to cut now. Some, such as the new Coalition government in the UK, want to cut the deficit quickly in order to appease markets and avert a Greek-style crisis and a lack of confidence in the government’s ability to service the debt. Others, such as the Obama Administration in the USA, want to cut more slowly so as not to put the recovery in jeopardy. Nevertheless, cuts were generally agreed, although agreement about the timing was more vague.
So where is the fallacy of composition? If one country cuts, then it is possible that increased demand from other countries could drive recovery. If all countries cut, however, the world may go back into recession. What applies to one country, therefore, may not apply to the world as a whole.
Let’s look at this in a bit more detail and consider the individual elements of aggregate demand. If there are to be cuts in government expenditure, then there has to be a corresponding increase in aggregate demand elsewhere, if growth is to be maintained. This could come from increased consumption. But, with higher taxes and many people saving more (or reducing their borrowing) for fear of being made redundant or, at least, of having a cut in their incomes, there seems to be little sign that consumption will be the driver of growth.
Then there is investment. But, fearing a ‘double-dip recession’, business confidence is plummeting (see) and firms are likely to be increasingly reluctant to invest. Indeed, after the G20 summit, stock markets around the world fell. On 29 June, the FTSE 100 fell by 3.10% and the main German and French stock market indices, the Dax and the Cac 40, fell by 3.33% and 4.01% respectively. This was partly because of worries about re-financing the debts of various European countries, but it was partly because of fears about recovery stalling.
The problem is that cuts in government expenditure and rises in taxes directly affect the private sector. If government capital expenditure is cut, this will directly affect the construction industry. Even if the government makes simple efficiency savings, such as reducing the consumption of paper clips or paper, this will directly affect the private stationery industry. If taxes are raised, consumers are likely to buy less. Under these circumstances, no wonder many industries are reluctant to invest.
This leaves net exports (exports minus imports). Countries generally are hoping for a rise in exports as a way of maintaining aggregate demand. But here we have the fallacy of composition in its starkest form. If one country exports more, then this can boost its aggregate demand. But if all countries in total are to export more, this can only be achieved if there is an equivalent increase in global imports: after all, someone has to buy the exports! And again, with growth faltering, the global demand for imports is likely to fall, or at best slow down.
The following articles consider the compatibility of cuts and growth. Is there a ‘paradox of cuts’ equivalent to the paradox of thrift?
Articles
Osborne’s first Budget? It’s wrong, wrong, wrong! Independent on Sunday, Joseph Stiglitz (27/6/10)
Strategy: Focus switches from exit to growth Financial Times, Chris Giles (25/6/10)
Once again we must ask: ‘Who governs?’ Financial Times, Robert Skidelsky (16/6/10)
Europe’s next top bailout… MoneyWeb, Guy Monson and Subitha Subramaniam (9/6/10)
Hawks hovering over G20 summit Financial Times (25/6/10)
G20 applauds fiscal austerity but allows for national discretion Independent, Andrew Grice and David Usborne (28/6/10)
To stimulate or not to stimulate? That is the question Independent, Stephen King (28/6/10)
Now even the US catches the deficit reduction habit Telegraph, Jeremy Warner (28/6/10)
George Osborne claims G20 success Guardian, Larry Elliott and Patrick Wintour (28/6/10)
G20 accord: you go your way, I’ll go mine Guardian, Larry Elliott (28/6/10)
G20 summit agrees on deficit cuts by 2013 BBC News (28/6/10)
IMF says G20 could do better BBC News blogs: Stephanomics, Stephanie Flanders (27/6/10)
Are G20 summits worth having? What should the G20’s top priority be? (Economics by invitation): see in particular The G20 is heading for a “public sector paradox of thrift”, John Makin The Economist (25/6/10)
Why it is right for central banks to keep printing Financial Times, Martin Wolf (22/6/10)
In graphics: Eurozone in crisis: Recovery Measures BBC News (24/6/10)
A prophet in his own house The Economist (1/7/10)
The long and the short of fiscal policy Financial Times, Clive Crook (4/7/10)
G20 Communiqué
The G20 Toronto Summit Declaration (27/6/10) (see particularly paragraph 10)
Questions
- Consider the arguments that economic growth and cutting deficits are (a) complementary aims (b) contradictory aims.
- Is there necessarily a ‘paradox of cuts’? Explain.
- How is game theory relevant in explaining the outcome of international negotiations, such as those at the G20 summit?
- Would it be wise for further quantitative easing to accompany fiscal tightening?
- What is the best way for governments to avoid a ‘double-dip recession’?
Under its terms of reference the new Office for Budget Responsibility is required to provide updated forecasts for the economy and the public finances at the time of each Budget in order take into account the impact of those measures contained in the Budget. Here we consider those economic forecasts contained in the June 2010 OBR Budget Forecast relating to economic growth. In particular, we consider the OBR’s interpretation of how growth is likely to be affected by the policy measures unveiled by George Osborne in his first Budget as Chancellor of Exchequer on 22 June.
The OBR forecasts that the UK economy will grow by 1.2% in 2010 and by a further 2.3% in 2011. These estimates are lower than those published by the OBR in its Pre-Budget Forecast published on 14 June. The Pre-Budget Forecasts predicted growth of 1.3% in 2010 and 2.6% in 2011. The downward revisions reflect the OBR’s assertion that the Budget’s measures to meet the Government’s fiscal mandate and, hence the resultant fiscal consolidation package, will weaken aggregate demand.
In terms of the components of aggregate demand, the fiscal consolidation will mean restraints on government spending (G) and, if the OBR is right, lower growth in household consumption (C). Lower consumption growth is expected as a result of reduced growth in household incomes and the rise in the standard rate of Value Added Tax next January from 17½% to 20%.
The OBR now forecasts that real household consumption will grow by just 0.2% in 2010, following last year’s contraction of 3.2%, and by 1.3% in 2011. General government final consumption – the Government’s expenditure on current goods and services – is forecast to grow in real terms by 1.7% this year before falling by 1.1% next year. The forecasts for general government capital spending are for a real fall of 4.9% this year, following last year’s rise of 15.7%, followed by a sizeable 19% decline in 2011.
A more positive note emerging from the OBR forecasts relates to capital expenditure by businesses. The measures to reform corporation tax, which include a reduction in the main rate of corporation tax from 28 per cent to 24 per cent over four years beginning with a one per cent reduction from April 2011, are predicted to have a favourable effect on investment. Business investment is forecast to rise in real terms by 1.4% this year, following last year’s fall of 19.3%, and to rise again in 2011 by 8.1%.
The projections for growth from 2013 are now stronger than in the OBR’s Pre-Budget Forecast with the economy portrayed as adjusting more quickly at this point towards its potential output. Potential output is the level of output level when the economy’s resources are operating at ‘normal capacity utilisation’. But, in 2015, which is at the end of the OBR’s five year forecast period, the UK economy is still forecast to be experiencing a negative output gap. In other words, actual output will still be less than potential output.
To help paint a picture of how the economy’s output will adjust towards its potential level consider the OBR estimates for the output gap. The OBR estimates that in financial year 2009-10 the economy’s output was 4.1% below its potential. This negative output gap is now expected to be reduced to 3.7% of potential output in 2010-11, to 2.8% in 2012-13 and to 0.9% of potential output in 2015-16.
Office for Budget Responsibility
OBR home page
Office for Budget Responsibility Terms of Reference
Documents
Budget Forecast June 2010 OBR (22/6/10)
Pre-Budget Forecast June 2010 OBR (14/6/10)
Budget 2010 HM Treasury (22/6/10)
Articles
OBR endorses Budget but faces questions over its own predictions Telegraph, Philip Alrdrick (23/6/10)
UK growth forecasts could be revised again, says Sir Alan Budd Citywire, Deborah Hyde (23/6/10)
OBR says growth will take bigger hit Financial Times, Norma Cohen (22/6/10)
Budget 2010: Government cuts will slow economic recovery, says watchdog Telegraph, James Kirkup (23/6/10)
Highlights from the Budget BBC News (22/6/10)
Budget statement: George Osborne’s speech in full BBC Democracy Live (22/6/10)
Questions
- What do you understand by the concept of aggregate demand?
- What are the component expenditures of aggregate demand? Which of these do you think is the largest in value terms?
- The OBR is forecasting the household sector’s disposable income to grow in real terms this year by 0.2% and by 1.2% next year. Why then is the OBR identifying weaker consumer demand as a result of the Budget measures as a major reason for revising down its predictions for economic growth?
- The OBR argues that the fiscal consolidation measures will have a ‘direct effect’ on household incomes and so on spending, but that this will be ‘partially offset by a decline in saving’. Why might the OBR be arguing that a fiscal consolidation will lead to a decline in saving? Evaluate the OBR’s arguments.
- What do you understand by the concept of an output gap? What does a negative output gap signify?
- To see the sorts of problems that forecasters commonly face, try identifying reasons why the output gap could be eliminated more quickly or less quickly as a result of the Budget measures.
As one of his first acts, the new UK Coalition government’s Chancellor, George Osborne, set up an independent Office for Budget Responsibility (OBR) (see Nipping it in the Budd: Enhancing fiscal credibility?. The role of the OBR is to provide forecasts of the economy and the data on which to base fiscal policy.
On 14 June, the OBR produced its first forecast in time for the Budget scheduled for 22 June. It has some bad news and some good news. First the bad news: it forecasts that growth for 2011 will be 2.6% – down from the 3–3.5% forecast by Labour in its last Budget in March. But now the good: it forecasts that the public-sector deficit in 2010/11 will be 10.5% of GDP – down from the 11.1% forecast by Labour; and that public-sector debt will be 62.2%, not the 63.6% forecast by Labour. These forecasts are before any policy changes announced in the Budget on 22 June.
Meanwhile, the accountants BDO have published a survey of business confidence. This shows the largest drop since the survey began. Talk by the government of cuts and worries that this will impact directly on the private sector have caused many businesses to cut investment plans. The worries are compounded by fears of a decline in export demand as countries abroad also make cuts.
So what does the future hold? Should we put any faith in forecasts? And should we be more worried about a double-dip recession or by failure to make sufficient inroads to deficits to calm markets?
Articles
Growth forecast is cut but borrowing improves Guardian, Phillip Inman and Hélène Mulholland (14/6/10)
UK watchdog slashes growth forecasts Financial Times, Chris Giles (14/6/10)
Fiscal watchdog downgrades UK growth forecast BBC News (14/6/10)
OBR UK growth forecast downgraded BBC News blogs: Stephanomics, Stephanie Flanders (14/6/10)
‘Sorry it is so complicated’ BBC Daily Politics, Stephanie Flanders (14/6/10)
Britain’s new economic forecasts: what the analysts say Guardian (14/6/10)
Spending cuts under fire amid new borrowing forecasts Independent, Russell Lynch (14/6/10)
The self-fulfilling deficit spiral Guardian, Adam Lent (14/6/10)
UK business confidence sees ‘record drop’ BBC News (13/6/10)
Britain to avoid double dip but recovery will be weak, CBI warns Independent, David Prosser (14/6/10)
A winding path to inflation The Economist (3/6/10)
Is inflation or deflation a greater threat to the world economy? The Economist: debate (1/6/10)
A question for chancellor Osborne Financial Times, Martin Wolf (11/6/10)
Fiscal conservatism may be good for one nation, but threatens collective disaster Independent, Joseph Stiglitz (15/6/10)
Hawks v doves: economists square up over Osborne’s cuts Guardian, Phillip Inman (14/6/10)
Data and forecasts
Pre-Budget forecast Office for Budget Responsibility (14/6/10)
Pre-Budget Report data Google docs (14/6/10)
Forecast for the UK economy: a comparison of independent forecasts HM Treasury (May 2010)
Questions
- How reliable is the OBR’s forecast likely to be? What factors could cause the forecast for economic growth to be (a) an overestimate; (b) an underestimate?
- What is likely to happen to aggregate demand over the coming months? Explain.
- What is meant by the ‘structural deficit’. Why might the structural deficit fall as the economy recovers? Would you explain this in terms of a shift or a movement along the short-term aggregate supply curve?
- Which is the greatest threat over the long term: inflation or deflation?
- Do you agree that the debate about cutting the deficit is merely a question of timing, not of the amount to cut?
- Why may policies of fiscal tightening, if carried out generally around the world, involve the fallacy of composition?
- Is there any common ground between the fiscal ‘hawks’ and fiscal ‘doves’ (see the last Guardian article above)?
There is a new craze sweeping across nations. We might call it the Consolidation Conga! Across the world, and, in particular Europe, government after government seems to be announcing plans to cut its budget deficit. But, with so much focus on governments’ plans for fiscal consolidation it would be all too easy to ignore evidence of consolidation in other sectors too. In the UK, the household sector continues to show a zest for the consolidation of its own finances.
Figures from the Bank of England show that during April net unsecured lending, i.e. lending through credit cards, overdrafts and personal loans less repayments, was again in negative territory, this time to the tune of £136 million. This means that the repayment of unsecured debt exceeded new unsecured lending by £136 million. When an allowance is made for unsecured debt ‘written off’ by financial institutions, we find that the stock of unsecured debt fell by £827 million.
April’s fall in the stock of unsecured debt means that the household sector’s stock of unsecured debt has now fallen for 11 months in a row. Over this period the stock of unsecured debt has fallen by £11.47 billion or by 4.9%. Some of this fall is clearly attributable to the ‘writing off’ of bad debts since net unsecured lending has been negative in only 6 of these 11 months. However, this should not detract from our central message of a consolidation by households of their finances. Indeed, the sum of net unsecured lending over these 11 months is -£459 million. In other words, over the period from June 2009 to April 2010 the household sector made a net repayment of unsecured debt of some £459 million.
While the stock of unsecured debt has fallen by £11.47 billion since last June to stand at £220.77 billion in April 2010, the household sector’s overall stock of debt has fallen too, although only by £178 million to £1,459.5 billion. The much smaller decrease in total debt reflects an increase in the stock of mortgage debt by £11.291 billion over the same period. But, there are two points to make here. Firstly, it is difficult to over-play the fact that the overall stock of household debt has fallen. If we look at the Bank of England’s monthly series which goes back to April 1993, the first monthly fall in the total stock of debt did not occur until October 2008. In other words, the norm has simply been for total household debt to increase.
The second point to make is that the growth in secured debt has slowed markedly. The stock of secured debt in April was only 0.9% higher than a year earlier. But, more than this, the Bank of England’s Housing Equity Withdrawal numbers show that since the second quarter of 2008 the household sector’s stock of secured borrowing has increased by less than we would have expected given the additional housing investment, i.e. money spent on moving costs, the purchase of newly built properties or expenditure on major home improvements. This has resulted in what we know as negative Housing Equity Withdrawal (HEW). This again is evidence that households too are consolidating.
The desire for the household sector to consolidate and to reduce its exposure to debt is pretty understandable, especially given these uncertain times. But, as we discuss in Has the tide turned for Keynesianism?, there are dangers for national and global aggregate demand of mass consolidation. It remains to be seen if we can really afford for so many to be dancing the Consolidation Conga!
Articles
Housing market on a knife edge with no sign of sustained recovery in lending Independent, David Prosser (3/6/10)
UK mortgage lending edges higher BBC News (2/6/10)
Mortgage data raise housing recovery fears Financial Times, Norma Cohen (2/6/10)
Mixed lending data point to stagnant housing markets Reuters (2/6/10)
Mortgage approvals slightly higher Press Association (3/6/10)
Data
Lending to individuals Bank of England
Monetary and Financial Statistics (Bankstats) Bank of England (See Tables A5.1 to A5.7, in particular)
Housing equity withdrawal (HEW) statistical releases Bank of England
Questions
- What does a negative net lending figure indicate?
- If net lending is negative does this mean that the stock of debt is falling?
- What factors might be driving households to consolidate their finances?
- Discuss the potential economic benefits and dangers of households consolidating their finances.
- Of what significance is the extent of the household sector’s consolidation of its finances for: (i) the government and (ii) the Bank of England?