The stock market's wild ride has left investors playing a global game of Clue. They can identify most of the elements that seem to be conspiring to impoverish them after a glorious five-year bull run; what they do not know is who pulled the trigger and why now.
Was it Mr. Xi Jinping in China with a candlestick in the form of his slowing economy? Or Ms. Christine Lagarde at the International Monetary Fund with a revolver in the shape of ever-lower, party-busting growth forecasts? Or Ms. Angela Merkel, wielding the knife of a stalled German economy?
It's probably all of the suspects, and others, rolled into one, which still does not explain why it all went so wrong.
Here's a guess: It was Mr. Mario Draghi, president of the European Central Bank with a little help from a U.S. dollar that was getting a bit too big for its britches.
Scroll back a month or two, when the markets were still trundling forward. Everyone knew oil prices were coming down, though it was – still is – a matter of debate whether the fall was largely due to surging supply from the United States and Libya or because of waning demand. Everyone knew China and other high-growth emerging markets were slowing down – Brazil is close to recession – and everyone knew the U.S. Federal Reserve's quantitative easing was soon to end.
All the bad news seemed to be baked into the investing and trading equation, to the point that the Ebola outbreak, the war against the Islamic State militants in Iraq and the pro-democracy protests in Hong Kong failed to snuff out the party. Not long later, the party ended.
Oil is down 25 per cent from its recent peak in June, stock markets launched themselves into correction territory (a fall of 10 per cent, half way to a bear market, is considered a correction) and bond yields plummeted, reflecting a flight to quality as "risk-off" momentum overwhelmed the optimists. George Magnus, former chief economist at UBS, says that identifying the actual trigger event is like "searching for the Holy Grail." One of his theories is that the climbing U.S. dollar played a role in delivering the market punishment, although the theory is not popular.
"The rising dollar, and restrained U.S. trade deficit, could at the margin be adding pressure to U.S. foreign earnings projections and sucking liquidity out of global risks markets," he says. "It wouldn't surprise me if this was also putting the skids under the market."
Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London debt consultancy, thinks suddenly rising fears of the "Japanization" of the European economy – a deadly combination of zero growth and zero inflation, or outright deflation – was a big contributing factor. To him, the moment of ugly truth came two weeks ago when Mr. Draghi sounded exasperated about his ability to kill off the deflation threat and restore growth to the stalled euro zone economy ("Let's see," Mr. Draghi said about the fix-it measures announced so far, which may have kept the euro zone intact but have failed to restore growth).
"Draghi came across as defensive and evasive," Mr. Spiro said. "His 'whatever it takes' promise to fix the euro zone is a distant memory. Markets are now questioning the credibility of central bankers."
Still another theory comes from Jose Manuel Amor, partner at the Madrid financial consultancy Afi. He thinks the trigger event was collective weariness after the relentless string of bad news – waning growth in Europe, China and other emerging markets; the deflation threat; and stretched valuations and rising debt in Italy, France and the other uncompetitive economies that are showing immunity to reform. "In my view, large investors got tired of waiting for a change in the overall negative news flow seen since July, and got weary of the policy response," he says. "Most portfolios had seen sizable gains and decided to take some profits."
Looks like they took profits all together. When big funds pull out, the herd mentality, propelled by automated trading, can set in fast. The question is whether the herd will keep charging away before turning around. By Friday, it looked like the herd had at least slowed down.
My own view is that the fall in commodities that are considered the best harbingers of future growth – oil, copper, iron ore – is not steep enough to warrant anxiety attacks about a slowdown that will wreck economies and stock markets. Oil seems trapped in a high-stakes geopolitical poker game directed by the Saudis to choke off some expensive shale oil production. Copper has not fallen precipitously. Iron ore prices are down more than 30 per cent this year, but that could be the result of another game, this one played by the low-cost Australian producers in which victory would be defined as the death of their high-cost Chinese rivals.
That does not mean that markets will not become much more volatile after three years of flat volatility that came with the great dollops of quantitative easing (QE) from the U.S. Federal Reserve and the central banks of England and Japan, combined with a flood of cheapo bank loans from the ECB.
QE is now embedded in the DNA of every fund manager and trader in the planet and they cannot imagine a market without it, even though they know it will end. The transition to a QE-free world will not be smooth and the process will surely rattle the markets. But higher volatility will not necessarily translate into a market collapse, even if it will be nasty at points.
Eric Reguly