A storm in a teacup? A healthy correction? Have investors, or at least those fooled by two years of unnatural calm in stock markets, merely been handed an overdue lesson that share prices can fall suddenly as well as rise smoothly? Will we be sleeping soundly again by the end of the week?
The not-much-to-worry-about school has history on its side. Most stock market wobbles do not develop into something worse. There have been only three serious stock market plunges in the last 30 years or so (1987, the 2000-01 bursting of the dotcom bubble and the banking crash of 2008) but many more corrections along the way that appear as minor deviations on today’s charts.
In the same spirit, Monday’s 1,175-point slide in the Dow Jones industrial average made for exciting viewing but, in truth, the numbers did not light up the dial. Even a sudden 4.6% drop does not count as proper drama in the context of a US stock market that has risen (still) by about 50% since early 2016. And, remember, the economic backdrop in the US is falling unemployment and rising wages, which is good news.
Nevertheless, there are alarming features to the market action. The first is the uniformity of opinion that normal service will resume soon. The pundits, analysts and fund managers rolled out by US financial TV channels on Monday night all said the same thing: it’s a correction, a reset, an adjustment. They’re probably right but, perversely, it would be more encouraging if there were a range of views: groupthink is not reassuring.
Second, the past couple of days have shown one thing – that there was an awful lot of money betting on tranquillity via various financial products manufactured by investment banks. Did a wipeout of some of these low-volatility funds feed the selling pressures on Monday? Almost certainly. But is that “technical” factor a temporary sideshow that can be ignored? Not necessarily. It may be evidence that other risks have been packaged up and sold as “low risk” when they’re actually the reverse. When investors are fed cheap money for a decade, dumb bets can be made.
Third, the prelude to the drama was a rapid rise in the yield on 10-year US treasuries from 2.4% to 2.8%. This, we are told, happened because the strong news on jobs and wages means the US Federal Reserve will have to raise interest rates three times this year. That explanation is entirely plausible. But a 10-year yield of 2.8% is still low by historical standards. What would something more normal – say, 4% – do? If the deflation dragon really has been slain and the Trump administration is dishing out tax cuts, isn’t 4% a possibility? On the evidence of the past week, the stock market may not adjust easily.
To repeat: the correction thesis is probably correct and the consensus view that calm will return is perfectly sensible. But the seemingly rock-solid certainty behind the idea is unsettling. After a bull market in shares that has lasted nine years, you’d expect to hear more scepticism.
Carillion was no place for blind optimism
“Clearly with the benefit of hindsight, should the board have been asking further, more probing questions, perhaps?” said Keith Cochrane, the former non-executive director of Carillion who was handed the (PFI) hospital pass and became stand-in chief executive after the huge profits warning in July 2017. What do you mean “perhaps”? Is there any doubt about it?
Cochrane’s qualification was probably unintended since he clearly believes the board should have done more. But it was typical of the exchanges between MPs and the failed directors. Board members pleaded that their judgments were fair at the time and made on the basis of the facts as they appeared. Blind optimism would be a better description of their approach.
Carillion was the second biggest beast in a UK construction industry where failures are hardly unknown, profit margins have always been thin and cost overruns happen often. The setup screamed for a conservative approach to funding in case of unforeseen events, such as the difficulty in getting Qatar to pay a £200m bill. Its former finance director Zafar Khan added other supposed bolts from the blue – Brexit and last year’s snap election – without wondering why competitors had managed to survive such calamities.
Frank Field and Rachel Reeves, the two MPs chairing the inquiry, called the failed directors “delusional characters”, a judgment that almost seemed charitable by the end of the session. Construction is a risk-management business, and always has been.