Markets Still Deeply Vulnerable

The Financial World According to Inya” Column
by Inya Ivkovic, MA

Last week demonstrated just how deeply vulnerable markets still are. First, the market reacted violently to the crisis in Greece, clearly demonstrating that every player on the global stage can cause the falling domino effect. Further exacerbating things are the stressed out investors, who seem to have the energy and inclination only to expect more bad news.

Then came China and its latest efforts to cool off its overheated credit market and, by extension, the country’s entire economy. Notably, Chinese banks received their marching orders to increase required reserves for the second time in the last 45 days or so. Of course, this is only a modest measure and it does not qualify as a measure to slow down an economy. China’s economy is expected to grow approximately 10% this year, partly because there is still billions of dollars sloshing around China’s financial systems. Regardless, North American investors looked for the smallest excuse for bad news and China’s latest policy decision, albeit very moderate, must have qualified.

All this nervousness could mean that the market is heading for a major correction in the short term, which may or may not develop into something more serious, such as another collapse just short of an actual crash. A collapse versus a full-out crash may seem like making a distinction without a difference. Apparently, the difference exists; that is, while a market crash happens abruptly, spawns panicky selloffs and reaches very deep, a collapse develops more slowly, and it is less steep and less upsetting to investors, because it gives everyone time to unwind their non-performing positions.

Investors must feel it in their bones that current market conditions could lead to a collapse, and potentially even to a crash. After the influx of government money into the financial systems around the world, excess liquidity has spilled over into the securities markets. The stocks started performing extremely well, staging a noteworthy comeback in 2009. Not surprisingly, many investors started feeling as if the worst was over. Helping the euphoria of sorts were corporate earnings, most of which soared in 2009 after companies cut their costs down to the bare bones.

Almost a year later, the market seems to be at a major crossroad en route to recovery. One scenario sees the economy picking up the pace and absorbing the excess credit that the central bank was so obliging to pump into it last year. In turn, this is likely to lead to higher interest rates and the slowdown of investment in speculative markets. The alternative scenario could see the recovery stall, the flow of credit remain fixed in liquid markets, and the realization of perma-bears’ grim prediction of the dreaded W-shaped recovery, or going through a double-dip.

In any event, if this slow grind continues and if commercial banks do not start lending more aggressively, current signs of the correction could metamorphose into something much worse. Considering how jittery investors are now, imagine what might happen if really bad news resurfaces and investors become paralyzed and crazy with panic yet again. We could be talking about the insanely volatile markets that we had experienced in the fourth quarter of 2008 and early in 2009, crashing one day and soaring the next, making us all dizzy and nauseous from the horrific rollercoaster ride.