Fluctuations in mood

The financial markets are being hit by fluctuations in mood. One moment a recession appears unavoidable, then the next it is deemed unlikely. There is much to suggest prices will remain volatile.

The fact that there are “ups and downs” on the stock market is an old truism. Yet not all phases are the same. Sometimes the price fluctuations are sharper, and sometimes they are weaker. While the financial markets showed signs of being “well balanced” until early 2018, investor behaviour has been influenced by dramatic fluctuations in sentiment for over a year. The mood quickly shifts from jubilation to despair. In other words, one moment a recession appears unavoidable, then the next it is deemed unlikely.

There are two reasons for this toing and froing. Firstly, the markets are uncertain about the climate for economic growth. Around the world, growth has clearly weakened. However, the data does not point to either a recovery or an economic slump over the coming months. There is little leeway for the economy to slide further. As a result, the markets are reacting tentatively to any bad economic news – many investors fear it will not take much to trigger a recession. On the other hand, good news would spur a recovery just as quickly.

Secondly, the political risks are also causing abrupt changes in mood in this climate. If there’s a threat from one of the protagonists, investors start to fear an immediate escalation in the US-China trade dispute. A gesture of goodwill from the US or Chinese government and their fears are soon dispelled. Brexit also remains full of unexpected twists and turns – and the outcome is more uncertain than ever. All eventualities from a soft Brexit to a no-deal scenario appear conceivable.

Central banks attempt to steady the ship

The central banks are trying to calm the situation. They are cutting interest rates and purchasing assets. This helps to improve the mood on the markets, albeit short-term. Despite this, firm trust in the central banks would appear misplaced. This is partly because the benefits of these measures do not always last for very long. And the further the central banks stretch the limits of their capabilities, the less effective the measures themselves seem to be in the short term. There is also an increased risk in the long term that the generous monetary policy will create precisely the volatility that it seeks to counteract in the short term. It is widely accepted that cheap money can create the conditions for bubbles.

There is an increased risk in the long term that the generous monetary policy will create precisely the volatility that it seeks to counteract in the short term.

A cautious approach is justified

There is much to suggest that volatility will remain high for the time being: fears of recession remain strong with weaker growth, political risks are unresolved and the power of central banks in the event of a slump is more restricted than before. At the same time, share prices are high after years of interest rate cuts, creating the risk of a crash. This means a cautious approach to the portfolio is advisable, even if the mood on the financial markets is buoyant at the moment.

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