Dance of investor greed and fear

Dance of investor greed and fear
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First Published: Mon, Jun 09 2008. 11 16 PM IST

What next? Traders at the New York Stock Exchange. Analysts say if the global economy continues to slow and the rate of inflation keeps on rising, investors will face tough times ahead.
What next? Traders at the New York Stock Exchange. Analysts say if the global economy continues to slow and the rate of inflation keeps on rising, investors will face tough times ahead.
Updated: Mon, Jun 09 2008. 11 16 PM IST
Some days the pundits who are paid to provide rational explanations for the gyrations of financial markets don’t have to work too hard. But on Friday, the instant experts really had to earn their keep.
What next? Traders at the New York Stock Exchange. Analysts say if the global economy continues to slow and the rate of inflation keeps on rising, investors will face tough times ahead.
Here’s how the standard story goes. The US unemployment rate rose to an unexpectedly high 5.5%. It suggested recession, causing a 3% drop in the Standard and Poor’s 500 stock index. A weak economy means less inflation, so the US Federal Reserve won’t follow through on earlier indications of rate hikes. The confidence in low rates pushed down bond yields and the dollar, which in turn pushed up the oil price by a stunning 9%.
A glib presenter might get away with that collection of causes and effects. But the logic could easily be twisted in another direction. If oil prices are rising out of control, general inflation will rise. That will pull up wages, even if the economy is weak. Such a price-wage spiral would propel the Fed to raise rates. Both the dollar and bond yields should be rising as shares fall.
Leave all this logic behind. The most plausible explanation for Friday’s gyrations is irrational. What is going on is the interplay of largely blind investor fear and greed.
Investors have many reasons to be jittery. The financial system is de-leveraging, credit problems are mounting, inflation is rising and growth is slowing. In less liquid markets, a morsel of bad news can start a cascade of selling.
But greed has not been totally abandoned, not while there is enough liquidity around to keep the oil price rising by leaps and bounds. Investors are apparently willing to believe almost any optimistic story about commodity prices. They are happy to ignore the inevitable effects of super-high prices on demand, and the inevitable effect of lower demand on prices.
What next for the markets? Since emotions change faster than facts, it’s hard to tell. There will certainly be more puzzling days. But if the global economy is really slowing and inflation is really rising, investors will almost certainly have a tough few months—or years.
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First Published: Mon, Jun 09 2008. 11 16 PM IST
More Topics: Inflation | Credit | Financial Markets | Price | Oil |