This could be a turning point for the Equity Markets

By Marco Pietropoli, April 2010

More Blogs


Investment Performance

The VIX (CBOE Volatility Index) jumped more than 25% yesterday. This is fairly unusual and may mark a turning point for the Equity Markets. The VIX is deceptive in its title. It is not really a measure of volatility; it is a measure of perceived downside risk of the S&P 500 on the Chicago Board of Trade. As the VIX rises it often follows that Equities are moving to the downside.

So what is all the worry about? Surely everyone knows that we are out of recession? Isn't that what the politicians, central banks and the financial industry have been telling us these last few months?

The reality is that Equities had lost all connection with the real economy. Why did this happen? Well, if you print lots of money and actively try to destroy the value of money you get asset bubbles.

But surely the UK is ok, we managed to grow at 0.2% in the last quarter, isn't that good? Well not if you consider that the UK government is running a budget deficit of approximately 12% of GDP. This has to be brought under control or the UK will be in the sever problems moving forward.

So what is troubling the markets? Greek government bonds were downgraded to junk status yesterday and this had a big impact. I think that the markets assumed that a rescue package for Greece would always be forthcoming as the Europeans would do what it takes to safeguard the Euro. Well, the Euro area had months of discussions but a rescue package never arrived.

Even if a bailout does arrive now it may be too late for Euro stability (not too late for Greece) as in many ways the markets have moved on from focussing purely on Greece. What is really troubling the market now is the risk of contagion. Portugal, Spain and Italy are now being focused on as potentially the next victims. Once we start talking about Italy the problems in the UK will not be far behind.

The risk is a snowball effect. Who is exposed to government bonds sold by Greece or Portugal? Many financials hold government bonds as supposedly safe investments, how does this affect their capital reserves? If we started having a number of sovereign defaults a credit crisis could emerge again. A way of following money market tensions is to look at the Ted Spread (TED spread is calculated as the difference between the three-month T-bill interest rate and three-month LIBOR).

The Goldman Sachs story is also creating market tensions as this may be the tip of the iceberg and many more lawsuits against financials could take place as we try to understand what happened in the financial industry during this crisis.

The public and politicians are quite rightly concerned that the banks seem to be making robust profits after huge government bailouts. The tax payer is still significantly out of pocket but bonuses and profits in the financials seem to be completely out of sync with the rest of the economy. It is immoral and unsustainable for there to be capitalism on the upside and socialism on the downside.

Significant further regulation on the financial industry and maybe more lawsuits are definitely on the way. The uncertainty as to how this is all going to unfold may also cause more market tensions.


                                                   Medway Independent Financial Advisor