Stock market fragility

This is an audio transcript of the FT News Briefing podcast episode: Stock market fragility

Marc Filippino
Good morning from the Financial Times. Today is Wednesday, December 1st, and this is your FT News Briefing.

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Marc Filippino
The new Omicron variant and a more hawkish sounding Fed chair spooked investors yesterday, and the world’s biggest clothing retailer has new leadership. Plus, the recent stock market turbulence has market watchers talking about fragility.

Robin Wigglesworth
When the calm breaks, it breaks with more ferocity than it would have been a few years ago.

Marc Filippino
We’ll talk with Robin Wigglesworth about the recent market swings and whether there’s cause for concern. I’m Marc Filippino, and here’s the news you need to start your day.

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Marc Filippino
US stock markets were rattled yesterday by fears over the Omicron coronavirus variant and comments from Federal Reserve Chair Jay Powell. The S&P 500 finished the day almost 2 per cent lower. Brent crude oil prices slipped nearly 4 per cent. Powell was speaking to US lawmakers and signalled his support for a quicker tapering of the Fed’s pandemic bond buying scheme. He cited the increased risk of higher inflation. But the FT’s US economics editor Colby Smith says the Fed has to balance competing forces.

Colby Smith
So with this new variant, what that could mean is more intense supply chain disruptions, more intense bottlenecks as well, and all of those factors are going to contribute, perhaps to higher prices. But at the same time, if fears of catching Covid are keeping people from re-entering the workforce again, you know that could also mean that on the labour market front the recovery is even patchier than it has been over the past couple months. So it’s a really, really difficult position that the Fed is in at the moment. But they have a dual mandate — meaning price stability and full employment — so if inflation does genuinely get out of control, I don’t think the Fed would hesitate to tame it.

Marc Filippino
Colby Smith is the FT’s US economics editor.

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Marc Filippino
So this market turbulence started last Friday. It was triggered by concerns about the Omicron variant. Stocks and oil prices had their biggest drops in more than a year. Before this, investors had gone a while without this kind of turbulence. The intensity of this plunge after a long lull has people talking about market fragility. Our global finance correspondent Robin Wigglesworth has been writing about this, and he joins me now to talk about it. Hey, Robin.

Robin Wigglesworth
Hi Marc, how are things?

Marc Filippino
Things are good. So Robin, if I understand this correctly, market jolts are getting less frequent but more intense, you know, why is that?

Robin Wigglesworth
Well, fundamentally, you’re right. The markets have evolved quite dramatically over the past two, three decades, but especially since the financial crisis. Nowadays, it’s essentially high. frequency trading, it’s algorithms trading with other algorithms at speeds that are unfathomable. That has meant that trading is cheaper than ever before. But it also means that markets react very quickly to shifts in sentiment. And one of the phenomena that has always been with financial markets that, when markets are turbulent, it’s harder to sell and the impact of you selling something is far greater than it would be normal times. That has always been the case, (but it seems to) be becoming even more pronounced over the past 10 years. And that, along with many other factors, is why people are talking about how the market system is is more fragile than many people really appreciate.

Marc Filippino
Right. And for people who like charts and numbers, there’s the Vix index. That’s the index that measures expected volatility, and it jumped 10 points on Friday. And it’s, you know, it’s been up a few times over the past few years.

Robin Wigglesworth
So broadly speaking, the stock market is actually more tranquil than it has been (sic) history. And then it has had spikes, for example March 2020 and then on Friday. But the spikes are bigger and the and the troughs are deeper than they have been in the past. So if you look at the volatility of Vix, which is a separate index called VVIX, that has generally been trending up for 20 years.

Marc Filippino
So Robin, some people point to central banks and say, “Hey, you know, holding interest rates so low encourages risk taking, and that leads to volatility”. How does that play into this idea of market fragility that we’re talking about?

Robin Wigglesworth
Well, it explains both why volatility has been lower and markets bouncier in the good times and why when the calm breaks, it can break ferociously. But markets snap back pretty quickly. Because fundamentally, what we’ve seen over the past say, 12 years since the financial crisis, is that central banks have acted more aggressively to forestall any potential financial crises. So whenever markets are thrown in a tailspin because of some sort of event, such as a global pandemic, they act so forcefully that the market drop, although severe, bounces back very quickly. And that encourages people to take on more risks because they know that central banks have their back. And that all works fine until there is some event that is so big, it does cause markets to drop. Because they’ve kind of gone over their skis so heavily in taking risk, the drop is that much more severe. But again, that old feedback loop kicks in again where people realise, oh, well, central banks have got our backs. Let’s just load up on risk again, and we start the whole cycle once over again.

Marc Filippino
Right, and this idea that central banks have the markets’ back only goes so far. Think about right now where central banks all over the world are raising interest rates or they’re talking about raising interest rates to try to tackle inflation.

Robin Wigglesworth
Well, this is what people are worried about might kill this, this this market regime, as people call it. There are many other facets to it. So there’s the liquidity provision, HFT, the many investment funds that ratchet up how much, you know, the stock market exposure automatically based on how volatile things are. And then the central bank puts, as people call it. But the danger is that the central bank put might be the most powerful force of them all. And if inflation does accelerate or stay high from here, it might mean that central banks feel their hands are tied when it comes to reacting to a market swoon. And that kind of short circuits the central bank put that people have relied on for 12 years now. And buying the dip, which has been the winning strategy for the past, yeah, decade, suddenly doesn’t work any more. And people get their faces ripped off as the old Wall Street adage goes.

Marc Filippino
So Robin, how nervous should we actually be? Because last time we spoke, you warned of risk in private markets. Now you’re talking about the risk in public markets (laughter). Are you just trying to be a little scary here? You know, is there any positive upshot that we can take away?

Robin Wigglesworth
Well, it’s just congenital to financial journalists, right? We’re all worried about missing out on some apocalyptic disaster (laughter). So we cover our arses. You know, broadly speaking, I’m an optimist. I tend to think that things tend to work out in the long run. Financial markets will be higher in a decade’s time. You will probably have made money in both public markets and private markets and so on. But the journey there can be fairly violently discombobulating. And I always worry about the, how various factors can rub off against each other. That if you think of the markets as like a big watch, if one of the cogs kind of breaks, how does that affect all the other cogs? So how can something happen in public markets lead into private markets or vice versa? How can central bank policy affect procyclical risk-taking and leverage and so on and . . . I think there’s a lot to watch out for. So yeah, I’m top, top level optimistic. But when I look at the guts and bowels of markets, I do get a little bit panicky at times.

Marc Filippino
Robin Wigglesworth is the FT’s global finance correspondent. Thanks, Robin.

Robin Wigglesworth
Thanks for having me on again.

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Marc Filippino
Shares in the world’s biggest clothing retailer were trimmed sharply yesterday. Inditex shares were down more than 6 per cent after the company, which owns clothing chain Zara, named its new chair. It is 37-year-old Marta Ortega. She is the daughter of Inditex founder Amancio Ortega. The appointment was supposed to end doubts over succession at the company, but investors seem to have been taken by surprise. The younger Ortega has worked in different parts of the business for the past 15 years, starting as a sales associate. Her appointment was part of a broader management reshuffle that includes a new executive chair who will play the leading executive role at the company.

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Marc Filippino
And a little bit more company news before we go.

Audio clip
Morrisons make good things happen.

Marc Filippino
British supermarket chain Morrisons is touting its green credentials with an announcement that its cage-free eggs will also be carbon neutral. How? The company plans to feed its egg producers — who would be chickens — with insects instead of soy-based chicken feed. It’s working with a start-up that will provide mini-insect farms to Morrison egg suppliers. Now you might be thinking, don’t chickens normally eat bugs? Yes, but raising birds indoors means that most of the feed comes from soyabeans and grains. Environmentalists have linked soyabeans and chicken feed to the destruction of the Amazon rainforest and the loss of biodiversity in Brazil.

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Marc Filippino
You can read more on all of these stories at FT.com. This has been your daily FT News Briefing. Make sure you check back tomorrow for the latest business news.

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