Why has the correction dragged on so long?
By
Simon Nixon Jun 21, 2006
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This market correction is lasting longer and proving deeper than many expected. It’s caught a lot of investors out, particularly many hedge funds, who initially stood their ground, expecting a quick bounceback. Given the pattern of recent corrections, that was the right call. Those who held their nerve, or bet against the market, usually made a killing. So what has gone wrong?
It is easier to look at all the things that haven’t gone wrong. There’s no geopolitical crisis to justify a big sell-off. Sure, there are tensions over Iran, the situation in Iraq is a mess and the surge in support for left-wing loonies in Latin America is worrying. But all these things are in the price already. Unless there is a new terrorist event, there’s nothing to justify a shift in risk appetite.
Nor have there been any worrying developments at a regional or national level – quite the reverse. I wrote here recently that weak European governments were a blessing for business and the markets, since they have only a limited capacity to meddle. Business thrives on stability. The same is true of the US, the world’s biggest economy. Lame duck Bush is the market’s friend.
There is no question of stockmarkets being overvalued. True, UK small and mid-cap stocks might have got a bit frothy on the back of bid speculation.
But it’s hard to argue that global stockmarkets are expensive. The S&P 500 index of US companies is at the same level as 1998. Yet corporate earnings are now 80% higher.
What does that leave? Two problems. The first is the behaviour of the hedge funds. Many of those that stood their ground in May hedged their positions by short-selling market indices. The snag is that, when everybody does this at once, it actually drives down prices further. It took until June for this steady drip-drip effect on share prices to lead funds to unwind their positions. This process may have some way to go, as many funds were behaving like geared long-only funds for much of the last year.
But longer term, the outlook depends on the second problem: Ben Bernanke. The new Fed chairman hoped to bring a more open and transparent process to policymaking. But his initial attempts to talk tough on inflation, and the subsequent back-pedalling, have left the markets thoroughly confused. Every time he opens his mouth, he seems to make the situation worse. And this is a man who gave three speeches last week. So the current volatility will continue until Bernanke regains his credibility.
I’m sure he’ll get there in the end. But after the last few weeks, it may take some time.
Holding back progress on climate change
The other evening, I had a rather strange experience. I’d just sat through a long homily on the catastrophic effects of global warming from one of the leading figures in the City when I suddenly found myself being blamed for making the whole problem worse. Okay, not me personally. His gripe was with the British press, which he said had stopped him from going nearly as far as he would like in showing leadership on climate change.
His real beef was that he wanted to launch a high-profile initiative that would have seen him offset his own “carbon footprint” via an exchange system that would allow him to buy credits from low carbon users. But he decided to back down after being warned he might become a target for pesky reporters who would draw attention to his own gas-guzzling lifestyle and call him a hypocrite.
What humbug! First, the UK press is obsessively supportive of anybody prepared to take the lead on climate change issues. Just ask Jeremy Clarkson, who was pilloried for suggesting that saving the planet did not require ordinary Britons to hand back the keys to the company Volvo. Second, my accuser was being hypocritical. There’s something medieval about rich men paying others to live like monks to salvage their guilty consciences.
More importantly, it’s not the press holding back progress on climate
change, but shareholders. True, the costs of cutting carbon emissions won’t hit the bottom line too hard at a financial-services firm. But if industrial groups with big energy bills unilaterally took on these costs, their margins would fall, their share prices would be hammered and investors would call for heads to roll.
Does that mean firms shouldn’t worry about the environment? Of course not. Firm must act responsibly. The bigger challenge is to help shift public opinion so that tackling climate change becomes good business because customers demand it. That can be done. Look at how public opinion has shifted on healthy eating, creating all sorts of new opportunities for food and drinks companies.
But this kind of leadership requires business leaders to make sacrifices.
That may be difficult to accept for rich men who have worked hard and feel entitled to their lifestyles. But paying other people to make those sacrifices on their behalf simply won’t wash.
Simon Nixon is executive editor of Breakingviews.com
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