Market volatility is rampant, indicating high levels of investor uncertainty. Will EU politicians resolve the crisis in time? Or will the contagion spread to France, the US and beyond? Asks Clem Chambers, CEO of ADVFN.com and author of investment guides such as “A Beginner’s Guide to Value Investing”.
Draghi’s speech was good news for many investors, prompting a market “pop” Friday, the global stock rallies driven by relief a definitive solution to the crisis appeared in sight once more.
This Thursday, however, the news out of Europe had precisely the opposite effect. While the ECB said it would prepare to buy bonds on the open market, it offered no “miracle” solution following the “crucial” meeting confirming it would be September before any measure could begin to be enacted.
Markets plunged, the FTSE 100 down 50 points, the France’s CAC and Germany’s Dax losing two percent, and Spain’s Ibex index tumbling more than five per cent.
These intense market reactions highlight just how amplified volatility has become. One day, indices swoon, the next, they zoom.
It’s exciting, but it’s not good news. It makes playing the stock market that much more dangerous.
If you compare your savings account with a stock, it’s easy to see why stocks are so much riskier during volatile times.
Profits from your savings account, however small will slowly tick up, as long as you don’t raid your account and your bank stays in business. Returns rise at a fixed level, they don’t go up and down. You can take a pencil and predict the future accurately without the need for specialist advice.
The predictability means you’ve got certainty, in return for which you take less profit than someone who puts their money in stocks.
A stock, on the other hand is liable to jump about, even if you’re sure in the long run that it will come good.
As the stock leaps around and carries a risk of things going wrong, you are rightly entitled to a fair chunk more profit along the way – to pay for the worry.
This is why risk equals return and this is why we invest in stocks – because all the stress means more profit in the long run.
The flip side to this is when markets start jumping about more than usual. This means the people involved have little clue which way the market or stock is headed.
If the future were obvious, then prices would be stable and price moves would more closely resemble that boring old savings account.
Right now, stock and commodity markets are reeling, which tells us the future is far from certain. This uncertainty is growing.
You could think that this uncertainty is good, because up until now, many people have been pretty certain about the demise of the euro – but that’s probably a bit too optimistic a way of thinking.
Markets are now heading toward several “pinch points,” the outcomes of which will have consequences that will shape the coming year.
The first is the US election.
A Romney win means severe austerity; an Obama reelection means much less retrenchment. My read is that Romney has almost no chance of election, so that’s “bullish” or encouraging for markets.
Historically-speaking, a successful re-election cycle means a stock market rally. The US election outcome seems obvious to me. Americans elect their presidents on the basis of who would they invite over for a barbeque. Of course, there is still time for Obama to lose it.
The second pinch point is purely technical. Markets are heading into a zone where the medium-term “uptrend” hits the long-term “downtrend”. There will be a fight over whether we are in a huge bear market or whether the credit crunch crash is over. This will coincide with the re-election result.
A Romney win at this point would seem to be catastrophic, unless – like many politicians promising budget rectitude – he simply throws the whole idea out the window.
Issue number three is that around the end of the year, the euro crisis needs to be over or it will suddenly be France’s turn. This would be extremely “bearish” or bad for the future direction of markets. A crisis in France would be even bigger than Spain’s current problems and would foreshadow contagion in the US.
Christmas 2012 is thus a period to be looking out to with tight focus. Worst-case scenarios? A Romney win, French contagion and confirmation that we are in a generational bear market whilst the Chinese economy remains weak.
On the other hand, a the best bull sequence would be an Obama victory, increasing stability in Europe and a break in equity markets out of the long-term bear phase we’ve been suffering. China switching to clear recovery mode would be a strong confirming signal that the global economy is on the road to recovery.
The fork in the road to either outcome seems to be right about now, which is why the market is currently swinging up and down so much. When this volatility subsides, the market direction will hint at what to expect in the following year.
Lets hope the trend is up.