JAPAN’S stock market fell around 7% today (averaging the Nikkei 225 and Topix performance) in what is probably a rational piece of profit-taking after the market’s phenomenal rally. The Nikkei started the year at 10,395 and had hit 15,627 before today’s plunge – a virtually uninterrupted 50% rise. Reading the news reports, you can see two main reasons cited for the fall; some weak Chinese PMI data and yesterday’s testimony from Ben Bernanke. Both have a sufficiently broad impact to explain why other stockmarkets are falling today.
Turning to the Chinese PMI first, investors have been worried for some time that the economy might be shifting from a 9-10% growth rate to a (still impressive) 5-6%. One could see this year’s fall in commodity prices as an indication of the same sentiment. It is worth noting that, given China’s rapid growth rate, a fall in the manufacturing PMI does not convey quite the same gloomy message as it does in the west. Capital Economics calculates that
At face value, a sub-50 reading signals that manufacturing is contracting. In practice though, the PMI has averaged 49.8 over the past 12 months, with industrial output expanding 9.5% y/y over the same period.
Nevertheless, the decline in the new orders component may be a bad sign for the rest of the global economy, given China’s role in world trade. Over in Europe, the PMI came in rather better than expected, at 47.7 for the composite measure, although it still points to contracting GDP.
The markets have been able to shrug off weak data in the past because central banks will ride to the rescue. So that is why they obsess over the minutiae of Ben Bernanke’s statements. The text was initially taken as dovish, warning of the risk of “premature tightening” but in the Q&A, he said that if there were improvement in the economic data and
we have confidence that that’s going to be sustained then we could in the next few meetings take a step down in our pace of purchases
This seems a classic “on the one hand, on the other” formulation. Note also that he was not talking about stopping QE or indeed about reversing all the asset purchases, just slowing the rate of accumulation. It shows how dependent the equity bulls are on QE that sentiment could be so badly hit by such an adjustment. Simon Smith at fxpro commented that
The message is markets have to remind themselves that in many ways they are living on borrowed time and the Fed is doing their level best to prepare them for the fact that they cannot continue to buy $ 85bln of assets a month forever. We could well be headed for a much more volatile summer.
He might be right about the volatility although I suspect that central banks, including the Fed, will not sit idly by in the face of either a big fall in the stockmarket or a sharp rise in bond yields. After all, the “wealth effect” is one of the reasons they cite for the US recovery, tentative as it is.
I’ve suggested in the past that once you go down the path of using monetary policy to support asset prices, it’s very hard to escape from it; indeed that is the lesson of the last 30 years. It is another form of moral hazard, like paying off a blackmailer; the markets always want more.
Equity markets: Please, sir, I want some more
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