Stocks and bangs

Quiet time is over

bull and bear market, stock market
Gearing up for 2018. Source: Bloomberg

Those people who claim that stock markets don’t deal with real data, just sensations and bad news, were proved wrong in 2017. Stock markets grew this year thanks to the global economy performing extremely well and companies reporting record profits. Investors were hardly influenced by the fact that US President Donald Trump has been fiddling with global structures, calling diplomacy and previously solid alliances into question.

In 2017, more than ever before, it was apparent that stock markets are a reflection of the economy, not a gambling table. That will remain the same next year, but troubled times lie ahead.

More surprising than the strong price gains in the past 12 months was the low volatility of the markets. From the DAX to the Dow Jones and the Euro Stoxx 50, prices in the major blue-chip indices rose respectably — and very slowly. Daily changes of more than 1 percent, which used to be the rule, became the exception in 2017 — the number of cases could be counted on one hand. Wall Street saw several periods of at least 40 consecutive trading days without price fluctuations of more than 0.5 percent.

Never before in the long history of the stock market have investors experienced such low price fluctuations. One reason has been the uniformity of the world’s economic upswing. For the first time in more than 10 years, there was growth in all major economic regions: the Americas, Asia and Europe. Gone are the days when China had to make up for the weaknesses of Europe, as was the case for a long time.

In other years, the economy led to severe turbulence, because economic data and early indicators sometimes sent out very good signals, followed shortly afterwards by very bad signals. Companies similarly would report good and then bad business. But the steady growth in 2017 put industrial groups, such as BASF and Covestro, in a position to impose higher prices, precisely because production was barely able to keep pace with the high global demand.

Never before in the long history of the stock market have investors experienced such low price fluctuations.

Central banks also aided the stock markets’ steady upward trend. The US Federal Reserve, the European Central Bank and many others provided consumers and companies with cheap money, and they searched for investment opportunities, which they found less and less with bonds and banks due to unattractive returns. The longer this lasted, the more money flowed into the stock markets. This was especially true as the markets’ rises were increasingly accompanied by lower volatility.

The stock market attracted more investors who had once avoided it because they could not tolerate price turbulence. Now, they were no longer afraid of it. Each quarter, prices were higher than the last. The strategy worked so well that a growing number of investors used trading algorithms to reflexively exploit even the slightest fluctuations in share prices. Because of that, prices that fell by more than 0.5 percent recovered within one trading day.

Next year does not promise a continuation of these steadily rising, low-volatility stock markets. Admittedly, economies in the big three economic regions are still growing robustly. But forecasts that go beyond three months cannot predict how long this blissful state of affairs will last. The one thing that seems certain is that the phase of cheap money is over. The central bank in the United States raised key interest rates three times in 2017. Expect another two or three rate hikes in the new year. In Europe, we’ll see the end of an era of central banks massively buying up government and corporate bonds, thus pushing their yields to almost zero. In other words, equities will face competition once again.

Also, after a nine-year bull market, it won’t be as easy to find new buyers with fresh money. As soon as the setbacks on the stock markets increase and computer-controlled buying programs stop working, volatility will increase. The angrier investors get, the more they will exit the stock market — triggering further fluctuations. There are many reasons to believe that prices on the stock market will again be turbulent in 2018, just like old times.

To reach the author:

We hope you enjoyed this article

Make sure to sign up for our free newsletters too!