Markets: Markets seem at a corrective turning point. Commodities have had one beating but may face another. Equities’ turn may be imminent. The biggest macro concern is the euro zone periphery. But there could also be a financial catalyst: as inflation drives up global interest rates and the US Federal Reserve brings its $600 billion money-printing encore to an end, markets will have to cope without free money.
There is emerging doubt over whether Europe will come up with the funds to pay for its crisis. The European Central Bank last week made plain its objection to funding Greek banks after a possible restructuring of Greece’s debt. Europe is bickering. The risk of outright default in Greece and major losses for bondholders is growing. The potential impact on European bank stocks scarcely bears imagining.
The euro had been appreciating against the US dollar as speculators profited by shorting the greenback. But the dollar carry trade is now in reverse. This has precipitated major falls in oil and other commodity markets. In the medium term, that is good for global growth. Near-term, it threatens the valuations of the oil and gas sector in particular.
The least noxious element of the current cocktail is evidence that policies to stop China over-heating are having some effect. Chinese manufacturing growth has slowed to a 10-month low. Still, it’s clear that the blithe combination of global recovery with ultra-low interest rates, money printing and the dollar as funding currency is over. A more sober world must be faced, in which US growth is moderate, Asian growth inflationary and euro zone growth is solid at the core and absent in the periphery.
Equity investors in previously buoyant emerging markets look especially vulnerable. The drop in the Shanghai stock market to a three-month low is indicative of the pressures.
Global equity funds had net outflows of $7.07 billion in the week ending May 18, says fund tracker EPFR. The S&P 500 index trades at a historic price-to-earnings ratio of about 15 - not bubbly, but nevertheless generous given the still slow US recovery and the prevailing global risks. Expect more money to come off before the summer.
