What is going on? Japanese Prime Minister Fumio Kishida proclaims his “new capitalism”, Japanese investors pile into stocks, driving the Nikkei average up to record highs, only for the Tokyo market to collapse like a house of cards and then partially bounce back. Other major markets have traced similar trajectories, although not of the same magnitude.
Tokyo’s sudden crash and equally sudden partial recovery speaks of a market support operation by the Bank of Japan (BOJ), which already held some 37 trillion yen (US$253 billion) of equity exchange-traded funds (ETFs) before the crash. This should not be mistaken for a true recovery.
As Reuters’ Jamie McGeever noted in a commentary this week, “day-to-day swings of this magnitude based on not a lot of fresh or major market-moving news are red flags. They’re typical of more protracted and volatile downturns, and many investors are adopting a cautious stance”.
Major markets – not least Wall Street – have been gyrating wildly. A simple case of midsummer market madness, perhaps? No, there is much more to it than that. Markets are beginning to reflect and respond to a fast-growing sense of uncertainty and insecurity in the wider world.
At the global level, this stems not from things such as shifting interest rates and inflation, though many analysts seem incapable of seeing beyond those. It reflects the growing risk of economic recessions, regional or global conflicts erupting, climate change, pandemics and many other threats.
Most of all, it means that more people are beginning to question whether their savings and investments are being well-managed and, if so, why financial markets are so volatile and prone to bubbles and busts at seemingly regular intervals.
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Why investors can expect more market volatility after recent global stock sell-off
Why investors can expect more market volatility after recent global stock sell-off
Why is so much money directed into so few tech stocks and into areas where corporate earnings expectations often vastly outpace the ability of companies to generate such profits? Why are some sectors such as artificial intelligence are flooded with financial liquidity – meaning our savings – while others such as the fight against climate change, the need to prepare for future pandemics, food and water shortages, infrastructure deficiencies and environmental degradation being sadly neglected?
The answer is that the structure of equity markets in general and the profile of companies listed on them is not aligned with the needs of the real economy. Markets have ceased to be efficient allocators of capital.
Portfolio investors are often more intelligent than those who manage their money. Yes, they can be talked into equity investment, as in the case of the massive sales drive by the ETF industry. However, many of these investors are sensing now that all is not well.
Where will the next big thing to dazzle the more gullible among stock investors and fund managers come from now that the shine is coming off AI technology and its supposed ability to generate unlimited profits, just as it came off the information technology boom some 20 years ago?
The fact is that the global fund management industry has short-changed market investors in general. It has sold them a limited basket of overpriced stocks when so much global economic activity has yet to be packaged properly and offered to savers.
Once animal spirits recover and the greed instinct reasserts itself, will anything have changed? The answer is that fear is likely to prevail over greed now that the smell of fear has been introduced by savage market swings.
The myth of an unstoppable boom in the US economy and on Wall Street is finally beginning to be dispelled. As Hung Tran, a senior non-resident fellow at the Atlantic Council observed in a commentary, several factors led to the sharp market correction.
Most important is the perception that the US Federal Reserve is behind the curve, having missed the opportunity to cut the Fed funds at its July meeting. “The fact that the unemployment rate (on a three-month moving average basis) has risen by more than 0.5 percentage points over its low in the previous year from its low of 3.5 per cent in July 2023 has heightened fears of an imminent recession,” Tran notes.
Stock market excitement in the past week is a harbinger of the volatility that is about to strike currency and bond markets, too. Some even attribute the global stock market turbulence to the surprise decision on July 31 by the BOJ to raise short-term interest rates for only the second time in 17 years.
It implies possible major changes in capital flows as the BOJ potentially prepares for further rate increases while the Fed prepares for a series of rate cuts in the face of a slowing US economy, as well as a presidential election in November.
The impact of this shift in interest rate differentials could be greatly magnified by the implied end of the “carry trades”, whereby investors use cheap yen to finance the purchase of higher-yielding currencies and then sell the yen again.
Currencies will oscillate along with bond yields as Japan seeks to attract portfolio capital back home by means of a stronger yen to pay for a proposed doubling of national defence spending, among other things. The Kishida government also needs foreigners to help prop up a Tokyo stock market in which his administration has much reputational and financial capital invested. Volatility is back with a vengeance.
Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs
