David Smith [Sunday Times]
WHAT is troubling the stock market? A month ago, after a late August
rally, world markets seemed to have embarked on their autumn climb.
Pundits competed to present the most bullish year-end predictions for
the big market indices. Even technology stocks, led by the Nasdaq,
joined the fun.
There were, it appeared, good reasons for optimism. August had passed
without the the Federal Reserve raising interest rates, which meant
there was little chance of a hike this side of the November
presidential elections. Similar optimism about the interest-rate
outlook was taking root in Britain.
The global economy had seemingly discovered the secret of
non-inflationary growth. In America, some of the froth was being
spontaneously removed. In Britain, a 25-year low for underlying
inflation coincided with an increasing belief that growth was becoming
better balanced and more sustainable.
But then, before you could say JP Morgan, it all evaporated. The
American slowdown, having been a source of relief to markets fearful
of rate hikes, suddenly became a source of concern to investors
worried about future earnings growth. Even low inflation, in Britain
and elsewhere, became a negative, emphasising companies' lack of
pricing power. September was a grim month on the world's markets.
Market sentiment can, of course, be highly volatile. Something of a
repeat of the late-August rally appeared to be under way on Thursday.
For no good reason, shares on Wall Street moved sharply higher. The
hunt for Black October - the particular danger of the market plunging
this month - may have to be postponed.
But the markets are picking up genuine economic worries. The question
is whether those worries are valid or whether, already, the clouds are
starting to lift. Gavyn Davies and Steven Strongin of Goldman Sachs,
in a paper, Oil Still has the Power to Shock, suggest that one of
those worries, high oil prices, could be with us for another 12 months
yet, because of the tightness of the supply- demand situation in the
market.
They suggest an average oil price of $27 a barrel next year, only
slightly below current levels of about $30, and calculate that this is
equivalent to the oil shock of the early 1990s generated by the Gulf
war. This would imply a hit to the net income of the industrialised
world of about 0.7%, and a boost to inflation of 0.9%.
This would be about a third of the effect of the first big oil shock,
in 1973-74, and about a quarter of the one that occurred in 1978-80,
after the fall of the shah of Iran.
My expectations have been for a rather shorter period of high oil
prices than this. After all, the Organisation of Petroleum Exporting
Countries (Opec) is already talking of the need to cut output if the
price is threatening to drop below $22 a barrel after the winter.
But the situation is finely balanced and America's release of 30m
barrels of oil from its strategic reserve, while it was welcomed by
the Group of Seven in Prague last weekend, was probably a mistake, a
sop to voters in America and something that has made Opec less
inclined to be helpful to the West.
If, even on the higher oil price predicted by Goldman Sachs, this
suggests that the world is fully able to take dearer oil prices in its
stride, there are two important caveats. The first is that, in a
low-inflation world, it may be harder for firms to pass on their
higher oil costs, implying a big squeeze on profits and therefore on
investment and jobs. This is what has had the stock market worried.
The second is that, as Goldman Sachs puts it: "Equity markets could
take fright, business and consumer confidence could collapse and the
monetary authorities could tighten policy (inappropriately) in
response to the rise in headline inflation."
Any of these, either separately or in combination, could turn an
unfolding drama into a crisis. Sir Eddie George spoke good sense last
weekend when he said that, unless there was evidence of damaging
second-round effects on inflation from higher oil prices, or a further
sustained rise, he would not be responding with higher interest
rates. It is to be hoped (and expected) he can persuade enough of his
monetary policy committee colleagues of this at their meeting this
week.
The International Monetary Fund, in its latest world economic outlook,
tried to put some flesh on one of the other dangers - a lasting
stock-market fall. A sustained 20% drop on Wall Street would, it said,
cut America's economic growth rate to 1% and, by sending the dollar
sharply lower, impact severely on the euro area.
Not only would the single-currency countries have to cope with the
direct wealth effects of lower stock markets, but they would also have
to live with a sharply higher euro. Britain would also be badly hurt,
if only as a piggy in the middle.
None of this need happen. The oil effect is real but containable. The
main fear in the markets may be fear itself. But there is a certain
fragility around, a worry that the good times, which in the case of
America and Britain seem to have lasted for ever, may be coming to an
end. Autumn optimism has given way to autumn nerves.
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