Where are world stock markets going and why?
See "What news is moving the market?" (business, page 4)By Jon Fernquest
[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
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Robert Shiller is the foremost expert in the world on stock market volatility. He is an economics professor at Yale University in the United States and author of the important book Irrational Exuberance.
Today he talks about why stock prices have been moving so violently recently. If there's anyone we should listen to about the stock market and its inscrutable movements, professor Shiller is the one.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. When did the current declines in world stock markets begin?
2. What is the important question that will be answered in the article?
3. Which country experienced the greatest declines?
4. What other developing countries experienced declines at the same time? How did they compare to India?
5. What developed countries experienced declines? How do these declines compare to the declines in developing countries?
6. What happened to stock markets in the United States and China? How did it compare to other countries?
7. What is the economist's standard explanation of the declines? How true is it?
8. What is the connection between stock prices and oil prices? Were oil price increases immediately reflected in stock prices?
9. What news related to oil prices had an influence over stock prices?
10. How important might the influence of the daily news be on stock prices compared to influences we normally expect like monetary policy?
11. Do stock price drops reflect actual changes or changes in the minds of investors?
Article
What news is moving the markets?
Robert J. ShillerStock markets in many parts of the world have shown sharp cumulative declines since around May 10, and mostly within the two-week period to May 23, with prices continuing to fall on average since then. So the question is, does trouble in the world's stock markets mean trouble for the world economy?
Let us look at the biggest declines. Of the major countries' indices, the biggest crash was in India, where stock prices fell 16.9% from May 10-22. The debacle on the other side of the globe was almost as big and the peaks and troughs were within a day or two of those in India: in Argentina, stock prices fell 16.1%, in Brazil, they fell 14.7%, and in Mexico, 13.8%.
European markets also suffered large losses. In Sweden, stock prices fell 15.2% from May 9-22; over nearly the same period, prices fell 9.7% in Germany , 9.4% in France and the United Kingdom, and 9.3% in Italy. Likewise, in Asia, stock prices fell 11.5% in Korea, 9.3% in Hong Kong, and 8% in Japan from their respective peaks to troughs over very nearly the same time period.
Many commentators try to tie such events to developments the United States. But US stock prices fell only 5.2% between May 9 and May 24. Nor does China appear to be behind the global decline, since stock prices there actually rose during this period.
Economists' standard explanation revolves around monetary policy. In the wake of the great deflation scare of 2003, central banks around the world cut interest rates, setting off speculative booms in both stock and housing markets. But now, according to this view, rising interest rates are beginning to bite, which portends further declines in asset prices.
There is certainly an important element of truth in this argument. The US Federal Reserve did indeed raise rates on May 10, and its chairman, Ben Bernanke, indicated then that there may be further rate increases in the future. Worsening US inflation data were reported on May 17, suggesting that further monetary tightening is in store.
Economists like to view the world as logical and manageable, which implies that they understand what is happening. But, in doing so, they often exaggerate central banks' roles. Indeed, the US rate increase was just one in a series of rate hikes, the 16th in a row. No other major central bank raised rates after the stock market drops began in May until June 7-8, when several did (the European Central Bank, India, South Korea, South Africa, Thailand and Turkey).
Another factor is the price of oil, which rose 24% from March 22 to May 2, setting records along the way. Surely, this was a major event that would plausibly affect stock markets all over the world. Oil price increases have been a culprit in virtually every economic recession since World War II.
Still, the oil price increases do not correspond to the time interval in mid-May when stock market indices fell most sharply. To argue that oil price increases caused the stock market declines presupposes a time lag of several weeks.
But stock markets are not very logical, and there could be a lagged response to the oil price shocks. As with any other prices in financial markets, an increase attracts attention. When oil prices rise quickly, people watch the news related to oil prices and talk to each other more about oil prices, hence creating heightened sensitivity to this news.
The crisis in the Middle East is tied to oil prices, and it dominated the news in May. Ominous signs and strong language by various political figures were possibly amplified in investors' minds by the oil price increases. On May 8, Israeli Vice Premier Shimon Peres, reacting to hostile statements by Iranian President Mahmoud Ahmadinejad, said that the president of Iran should remember that Iran can also be wiped off the map.
Similarly, near the beginning of the May stock market tumble, Mr Ahmadinejad visited Indonesia, the world's most populous country with a Muslim majority, and newspapers reported on May 13 that he had received a standing ovation from students at two of the country's top universities. This might have been interpreted as evidence that Mr Ahmadinejad's brinksmanship on the nuclear issue was paying off for him politically, fueling a perception that the tense situation in the Middle East might lead to even higher oil prices.
These news stories may seem far more remote from the stock market than is monetary policy. But public reaction to them, together with recent oil price increases, may well account in good measure for the change in market psychology. Attitudes toward risks change over time, and events such as the Ahmadinejad and Peres remarks can precipitate such changes. So, while these things happen in ways that are hard to quantify, maybe analysts should pay attention to the words of Mr Ahmadinejad just as carefully as they do to those of Mr Bernanke in trying to understand the direction of the world's stock markets.
Economists might not like to focus on the public mindset and how it interacts with price changes, world news stories, and speculative dynamics. After all, doing so implies that economic events are less predictable (and economists less omniscient) than they like to imagine. But such a focus makes intuitive sense. What is really on investors' minds? Mr Ahmadinejad is a charismatic figure; Mr Bernanke is not. Mr Ahmadinejad is embarking on an adventure; Mr Bernanke is not. And, perhaps most importantly, Mr Ahmadinejad is a destabilising influence; Mr Bernanke is not.
Indeed, whatever their ultimate cause, the mid-May drops in stock prices throughout the world are indicative of unstable market psychology. It is difficult to believe that they were related only to opinions about likely monetary policy, and not to larger and deeper issues, including such things as energy and political tension, that underpin the performance of the world economy.
Robert J. Shiller is a professor of Economics at Yale University, Chief Economist at MacroMarkets LLC, which he co-founded (see macromarkets.com), and author of 'Irrational Exuberance and The New Financial Order: Risk in the 21st Century'. Project Syndicate, 2006. www.project-syndicate.org
Vocabulary (in article)
cumulative declines - each decline added to the next to make the total effect greater
indices - stock indexes, measure the average level of stock prices in a country
a debacle - an event that is a complete failure
peaks - high points in the price of a stock over time
troughs - low points in the price of a stock over time
commentators - a person who writes in the news on a special subject like politics or sports
revolves around - is related to
monetary policy - the policy of a country's central bank to control interest rates, credit (loans), and the amount of money in the economy
in the wake of - after a big event
deflation - a time when all prices are decreasing
speculative booms - a time when prices increase because people are speculating not because there is any new value being created that is greater than in the past
beginning to bite - beginning to have an negative effect
portends - shows that an event is likely to happen in the future
element of truth - has some truth
monetary tightening - less credit (loans) and money circulating in the economy
rate hikes - increases in interest rates
culprit - someone who does something wrong
x presupposes y - x cannot be true unless y is true
time lag - delay, there is a delay in the effect of a change
lagged response - delayed response
heightened sensitivity - greater effect
ominous signs - events that show that unpleasant things are about to happen
strong language - language that makes threats of violence and death
amplified in investors' minds - became more important in investors' minds
hostile - like an enemy
wiped off the map - destroy completely
stock market tumble - fall in stock market prices
standing ovation - when an audience stands up and claps their hands after a performance
x might have been interpreted as evidence of y - people thought that x caused y
brinkmanship - when a politician gets into dangerous situations so they can gain fame when they avoid disaster and succeed
paying off - gain by doing something
fueling a perception - causes people to think that
precipitate - causes to happen
public mindset - the way the public thinks
speculative dynamics - the factors and logic that makes speculators speculate
omniscient - knowing everything, like god (or a god)
makes intuitive sense - you feel that something is true based on past experience
rather than hard evidence or proof
charismatic figure - someone who through their personality attracts, inspires, and influences many people
indicative of - shows that
Answer Key:
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