Sell in May and go away, don’t come back until St Leger Day.
So goes the old stock market adage and rarely has the first part of that advice been more apposite than this year. The FTSE 100 index peaked on 27 April, just before the general election, and has been on the slide ever since. It is now down more than 10% from its peak, so fulfilling the definition of a correction.
On the face of it, there seems to have been no real reason for the slide in the FTSE 100 over the summer. Markets should have been cheered by the return of a majority Conservative government in the May general election. The economy grew by 0.7% in the second quarter and continues to be boosted by ultra-low interest rates. That, too, should be a source of comfort. Cash and gilts don’t obviously represent a better place for investors to put their money. The crisis in Greece has abated, if only temporarily. Yet the selloff has continued.
Shares in London have fallen by more than they have on Wall Street and there’s an obvious reason for that: when compared to the Dow Jones Industrial Average, the FTSE 100 has a higher weighting of mining and commodity stocks. And that sector has taken a real caning as a result of weaker demand from emerging markets in general and from China in particular.
The jitters in the City have nothing to do with the state of the UK economy and nothing to do with the speculation that Greece might eventually be forced out of the single currency. They have everything to do with concerns that the next global financial crisis has begun in emerging markets.
As ever, the riposte to this suggestion is “it’s different this time”, with good reason considered the four most dangerous words in financial markets. Panglossian investors can always think up a hundred reasons why it’s different this time, up to the moment when reality smacks them in the face.
The optimists argue that China is adroitly easing its way to slower but more sustainable growth, that the fall in commodity prices has been caused by over-supply rather than a shortage of demand, and that the rest of the world has had plenty of opportunity to prepare itself for an increase in interest rates from the Federal Reserve later this year.
The pessimists would say that China’s hard landing is being disguised by dodgy official figures, that oil and metals prices are falling because demand is faltering and that the $1tn of capital that has flowed out of emerging markets in the past year is evidence of a sharp drop in investor confidence.
As Russell Jones and Bimal Dharmasena of Llewellyn Consulting note: “The export-led model has run its course. In many ways, it sowed the seeds of its own destruction, the emphasis on exchange rate competitiveness and foreign exchange reserve accumulation morphing into undue monetary laxity, excessive credit growth, asset price inflation, income inequalities, and malign financial imbalances similar to those built up in the advanced economies pre-2007.”
Many emerging market countries assumed that high commodity prices would last for ever. They spent up to their income, and then some. They now have a twin deficit problem: they are running budget and current account deficits. Capital flowed into emerging markets when zero interest rates in the west set off a search for higher yield in markets that were seen as a bit riskier but still safe. Now those markets are seen as not nearly so safe as they were and a lot riskier than the west.
There are two silver linings to this cloud. The first is that the renewed drop in oil prices will boost the spending power of consumers and cut business costs. The second is that the Fed looks ever more likely to delay its first rate rise from September to December. In part, that’s because of what’s happening in the financial markets. In part, it’s because the dollar is rising on the foreign exchanges, which has the same effect on the economy as an increase in interest rates, by making exports dearer and imports cheaper.
The question investors have to answer is whether this is enough to prevent a stock market correction from turning into a bear market, which is where shares fall by 20%. Should they take heed of the second part of the old saw and come back into the market once the last classic of the flat racing season has been run at Doncaster in the second week of September? Only the brave will consider it. It looks a bigger gamble than a flutter on the St Leger.
This article was written by Larry Elliott, for theguardian.com on Thursday 20th August 2015 19.33 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010