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business newsThe Global Economy and Markets: Q&A With Prieur du Plessis
By
Prieur du Plessis
Oct 04, 2011 11:45 am
The South African investment professional weighs in on Greece, Asia, and market volatility.
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The rout in global financial markets is continuing, characterized by extreme swings of up to 5% in some markets. What is the reason behind the extreme volatilities in the markets?
There are a couple of reasons but at this stage the major factor seems to be the possibility of Greece defaulting on its debt on its own terms. If that happens, the entire Eurozone financial system would be at risk as some major banks’ balance sheets will come under huge pressure. This in turn is likely to trigger a liquidity crisis that will certainly rub off on the rest of the world. In addition, the European Union would come under scrutiny, as would the existence of the euro.
If Greece defaults, can the world afford it? Is there a way out?
The European Union and the rest of the world cannot afford another liquidity crisis of the same magnitude as in 2008/09. I am of the opinion that Greece will be allowed an orderly default where some of its debt will effectively be written off by other governments, and that vulnerable banks will be recapitalized by the European Financial Stability Facility or EFSF that is financed by members of the Eurozone to combat the sovereign debt crisis. The debt crisis and Greece deadlock have already dented business confidence in the Eurozone and resulted in the contraction in both the manufacturing and services sectors of the economy.
What other factors besides the sovereign debt crisis contribute to the extreme volatilities in the markets?
Well, it is in fact a combination of factors. When the debt crisis started in the Eurozone’s Mediterranean countries and Ireland last year the big concern was always whether there would be contagion to other Eurozone countries and the rest of the world. Uncertainty was exacerbated by the uprisings in the MENA countries that started in earnest in January, resulting in a strong rise in the oil price due to supply concerns. Then in March Japan’s terrible twin disasters struck and had an immediate impact on China as global economic growth locomotive. Consumer and business confidence is under heavy pressure in the U.S. as employment has stagnated with austerity measures implemented in the government sector.
Although the rebuilding of Japan is on schedule the strong yen is hurting exports, while China’s normal seasonal strength in its manufacturing sector is below par. Growth in global manufacturing halted for all intents and purposes and a currency war between the majors developed with the Swiss and Japanese at the forefront to stave off further appreciation of their already overvalued currencies, resulting in the Swiss pegging their currency against the euro at lower levels.
What will bring the extreme volatilities down? What will calm the markets?
Good question! The markets obviously want to see central bank action that will ensure growth and, most importantly, restore confidence. Our studies have indicated that the most important factor in restoring order in financial markets is value. In fact, very rich market valuations and weakening economic indicators had resulted in increased volatility long before the 2008/09 market crash started. This behavior can also be traced to other stock market crashes over the past 40 years. Volatility subsided only when market valuations returned to levels where major investment houses saw good value again. That preceded better economic fundamentals.
No positions in stocks mentioned.
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