They say that every bull market has to climb a wall of worry. The current one has lasted for so long and has given such dazzling returns that many observers have wondered whether it is simply too good to last.
Their worries have been about a variety of things—the US current account deficit, a slowdown in the US or China, low risk premiums, excessive leverage. But chiefly, they have been about higher interest rates. The current bout of nervousness about rising US bond yields is by no means the first.
Here’s a short list of the concerns that have rattled global markets in the last few years.
Matters of interest
In early 2004, after a sharp recovery from the trauma of the post dot-com bust, the markets became obsessed with fears of a rate hike in the US.
The federal funds rate had fallen to a 45-year low of 1% and Alan Greenspan, then Federal Reserve Board chairman, was widely believed to be the genius who had single-handedly created the world’s biggest asset bubble. The “carry trade” in those days was all about speculators borrowing in low-interest US dollars and putting the money to work in high-yielding emerging markets. Once interest rates in the US started climbing, so went the argument, the flood of money would flow back to the US, leaving emerging markets high and dry. There was even a handy precedent: when interest rates in the US were raised in 1994, emerging markets crashed.
The upshot of all this was that in May 2004, emerging markets plunged across the globe as investors stampeded for the exits before the lights went out. The Fed did start raising interest rates in June and continued to raise them steadily thereafter, but none of the doomsayers’ dire warnings came true and the money flowed back.
But the doubters soon found something else to be scared about. This time, they pointed to the depreciating US dollar and declared that it was the reason for the outperformance of non-US assets. Let the dollar start appreciating, they said, and the emerging markets would collapse. Well, the dollar did start to reverse direction in January 2005, but after a month or so of nail-biting, investors carried on partying much the same as before.
About that time, Greenspan made yet another of his famous comments, this time to the effect that he was perplexed why long-term bond yields remained so low in the US in spite of several rate increases. So in April 2005, when the yield on the US 10-year Treasury note rose to more than 4.5%, the sceptics declared that the long-awaited Armageddon had finally arrived. Emerging markets dutifully fell across the board, but alas, only temporarily. The Sensex went up 43% between April and October 2005, when it was time for some more worrying.
This time, it was about inflation. Higher oil prices had resulted in inflation climbing to a 25-year high in the US. Bond yields again went up above 4.5% and emerging markets tottered. But once more, the reverses were short-lived.
The next storm to hit the markets was in May last year. This time, the source of the contagion was Japan. For years, interest rates in Japan had been very low, spawning a huge “carry trade”. But Japan was slowly getting out of its decade-long depression and the Japanese central bank started to tighten liquidity. In May 2006, Japan’s monetary base contracted by 15.6%, after the Bank of Japan stopped its policy of flooding its money markets with liquidity.
Central banks across the world had been slowly raising interest rates, spooked by the resurgence of inflation. The fallout: carnage in the equity markets. It took several months for stock markets to recover from the May 2006 crash, but recover they did and went on to post new highs.
And finally, we all remember the sharp sell-off in February this year, when a crash in Shanghai sparked a wave of selling in markets across the world, with the Dow seeing its biggest drop since 9/11.
The ostensible reason: the fragile state of the US housing market and fears of a US recession. We also know how the market put that particular worry behind it and how stock indices went on to make new highs not only in the US but in several other countries.That hasn’t, however, dampened the propensity to fret. The wheel has come full circle and instead of bothering about a US recession, the worriers are now concerned that inflation is making a comeback worldwide and interest rates will be forced up.
Those who were anxious about a US slowdown in February are now apprehensive that the world economy is growing too fast and that will lead to more demand for funds to increase capacity expansion, which in turn will lead to inflation.
Or, alternatively, India and China are growing so fast that food prices will fuel inflation. And all this worrying is going on at a time when consumer price inflation is lower in the US and in Euroland than a year ago, Japan has near-zero inflation and metals and crude oil prices are off their highs.
Hopefully, this time too, like all the earlier scares, we’ll see a market crash, followed by a recovery, giving investors an opportunity to make money by both shorting the market and buying thereafter.
Mint’s resident markets expert Manas Chakravarty looks at trends and issues related to investing in general and Indian bourses in particular. Comments are welcome at email@example.com.