Markets have seen sharp falls over the last few days, but there appears to be no good reason, except that the markets seem to be saying: the era of record low interest rates is near its end.Sometimes things happen for no good reason. The markets rise and they fall – but sometimes markets fall, or indeed rise out of randomness – they have to go somewhere. On occasions, the movements just happen to be sharper than normal, just as sometimes if you flip a coin you will get the same result ten times – in fact, the odds of that are around 1,028 to one, which may seem like long odds, but if you toss a coin every day, then once in every three years or so that will happen. A sharp fall, or indeed rise, whatever caused it, can become contagious, traders may start selling simply because the markets are falling, or buy to try and swim with the tide.
So if you factor in the laws of randomness, and combine this with herd instinct, then you have sufficient information to explain a lot of the more dramatic market movements. Stock markets crashed in 1987, but the explanation above may have applied to that particular fall.
But on other occasions we see markets collapse or boom because something significant has happened – for example, in 2008 the collapse of Lehman Brothers led to a massive fall across stock markets.
Finally, we get sharp falls or rises because a gradual change in market sentiment reaches a kind of tipping point. So in the year 2000, markets crashed as the gradual realisation crept in that dotcoms were over-priced.
On the afternoon and evening of Friday 9th September, markets in the US saw sharp falls. The selling spread to Asia by the Monday morning, and by the time you read this, you will know if it spread to Europe.
But drill down and the sell-off gets more interesting. For one thing, the stocks that have particularly suffered – not just on the 9 September but for several months – are so-called defensive stocks, that’s stocks that pay out high dividends, for example. These are the kind of shares that tend to do well when there is a mood of pessimism and badly when things seem to be improving for the wider economy. Well, they have been doing badly, while cyclical stocks, that tend to rise when the economy is strong, have been doing much better – so read into that what you will.
At the same time, the yields on government bonds have been rising. Such yields are still low, of course, but the recent trend is clear. Take the yields on UK government ten-year bonds – they had increased from a tiny 0.54% in the middle of August to 0.86 per cent by the Friday evening. Up until very recently, the yield on ten-year German government bonds, or bunds, was negative, but Friday evening it had risen above zero – just.
The markets seem to be saying that their view on interest rates in the longer term has changed – they are not predicting rate rises imminently – they are still very unsure, for example, about whether US rates will rise soon. But they do seem to be saying that the era of record low rates is at least drawing to a close –which may be good news as rising rates are usually associated with faster growth. Of course, they change their minds. But it is a trend to watch.