What News Is Moving the Markets?
Robert J. Shiller
Stock markets in much of the world have shown sharp cumulative declines since
around May 10, with most of the drop occurring in the two-week period to around
May 23, but with prices continuing to fall on average since then. Does trouble
in the worlds stock markets mean trouble for the world economy?
Let us look at the biggest declines. Of the major countries indexes, the
biggest crash was in India, where stock prices fell 16.9% from May 10 to May
22. The debacle on the other side of the globe was almost as big and the peaks
and troughs were within a day or two of those in India: in Argentina, stock
prices fell 16.1%, in Brazil, they fell 14.7%, and in Mexico, they fell 13.8%.
European markets also suffered large losses. In Sweden, stock prices fell
15.2% between May 9 and May 22; over nearly the same period, prices fell 9.7%
in Germany , 9.4% in France and the United Kingdom, and 9.3% in Italy.
Likewise, in Asia, stock prices fell 11.5% in Korea, 9.3% in Hong Kong, and 8%
in Japan from their respective peaks to troughs over very nearly the same time
period.
Many commentators try to tie such events to developments the United States.
But US stock prices fell only 5.2% between May 9 and May 24. Nor does China
appear to be behind the global decline, since stock prices there actually rose
during this period.
Economists standard explanation revolves around monetary policy. In the wake
of the great deflation scare of 2003, central banks around the world cut
interest rates, setting off speculative booms in both stock and housing
markets. But now, according to this view, rising interest rates are beginning
to bite, which portends further declines in asset prices.
There is certainly an important element of truth in this argument. The US
Federal Reserve did indeed raise rates on May 10, and its chairman, Ben
Bernanke, indicated then that there may be further rate increases in the
future. Worsening US inflation data were reported on May 17, suggesting that
further monetary tightening is in store.
Economists like to view the world as logical and manageable, which implies
that they understand what is happening. But, in doing so, they often exaggerate
central banks role. Indeed, the US rate increase was just one in a series of
rate hikes the 16th in a row. No other major central bank raised rates after
the stock market drops began in May until June 7- 8, when several did (the
European Central Bank, India, South Korea, South Africa, Thailand and Turkey)
Another factor is the price of oil, which rose 24% from March 22 to May 2,
setting all-time records along the way. Surely, this was a major event that
would plausibly affect stock markets all over the world. Oil price increases
have been a culprit in virtually every economic recession since World War II.
Still, the oil price increases do not correspond to the time interval in
mid-May when stock market indexes fell most sharply. To argue that oil price
increases caused the stock market declines presupposes a time lag of several
weeks.
But stock markets are not very logical, and there could be a lagged response
to the oil price shocks. As with any other prices in financial markets, an
increase attracts attention. When oil prices rise quickly, people watch the
news related to oil prices and talk to each other more about oil prices, hence
creating heightened sensitivity to this news.
The crisis in the Middle East is tied to oil prices, and it dominated the
news in May. Ominous signs and strong language used by various political
figures were possibly amplified in investors minds by the oil price increases.
On May 8, Israeli Vice Premier Shimon Peres, reacting to hostile statements by
Iranian President Mahmoud Ahmadinejad, said that the president of Iran should
remember that Iran can also be wiped off the map.
Similarly, near the beginning of the May stock market tumble, Ahmadinejad
visited Indonesia, the worlds most populous country with a Muslim majority,
and newspapers reported on May 13 that he had received a standing ovation from
students at two of the countrys top universities. This story might have been
interpreted as evidence that Ahmadinejads brinkmanship on the nuclear issue
was paying off for him politically, fueling a perception that the tense
situation in the Middle East might lead to even higher oil prices.
These news stories may seem far more remote from the stock market than is
monetary policy. But public reaction to them, together with recent oil price
increases, may well account in good measure for the change in market
psychology. Attitudes toward risks change over time, and events like
Ahmadinejads and Peress remarks can precipitate such changes. So, while these
things happen in ways that are hard to quantify, maybe analysts should pay
attention to the words of Ahmadinejad just as carefully as they do to those of
Bernanke in trying to understand the direction of the worlds stock markets.
Economists might not like to focus on the public mindset and how it interacts
with price changes, world news stories, and speculative dynamics. After all,
doing so implies that economic events are less predictable (and economists less
omniscient) than they like to imagine. But such a focus makes intuitive sense.
What is really on investors minds? Ahmadinejad is a charismatic figure;
Bernanke is not. Ahmadinejad is embarking on an adventure; Bernanke is not.
And, perhaps most importantly, Ahmadinejad is a destabilizing influence;
Bernanke is not.
Indeed, whatever their ultimate cause, the mid-May drops in stock prices
throughout the world are indicative of unstable market psychology. It is
difficult to believe that they were related only to opinions about likely
monetary policy, and not to larger and deeper issues, including such things as
energy and political tension, that underpin the performance of the world
economy.
** Robert J. Shiller is Professor of Economics at Yale University, Chief
Economist at MacroMarkets LLC, which he co-founded (see macromarkets.com), and
author of Irrational Exuberance and The New Financial Order: Risk in the 21st
Century.
Copyright: Project Syndicate, 2006.
http://www.project-syndicate.org/commentary/shiller38
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