Fear and irrational trading driving stocks down

Every now and then, global stocks markets diverge from economic fundamentals as fear, irrational trading and a herd mentality dominates market prices and hard news on the economy is ignored.

We are witnessing this phenomenon right now as stocks around the world are falling sharply, despite the bulk of the news on the economy remaining positive.

Such is the irrational market action, that the free-fall in oil prices is being seen as bad news for the prospects for global growth rather than a stimulus to consumer demand as the price of filling up the car drops sharply.

Also read: Chinese stock markets halted for day after shares fall 7%

To be sure, the oil and other energy producers are suffering as the oil price flirts with fresh 12 and 13 year lows.

Shareholder in those companies are, rightly, suffering from what will be weak profitability with oil prices in the doldrums.

But consumers will be saving 20 or even 30 per cent on their petrol costs.

This spare disposable income is certain to be spent elsewhere, as it has in the past when oil prices have fallen.

It reminds me of the old saying that rising and high petrol prices are a tax on economic growth.

This is true and the opposite is happening now - low petrol prices are like a tax cut for consumers.

It remains the case that the global economy is growing, at a respectable pace, with the unemployment rate falling in all major industrialised countries.

The headline grabbing downgrades to the global economic growth outlook in 2016 from the International Monetary Fund were actually a reduction the rate at which the pace of global economic growth will accelerate this year rather than signaling weaker growth.

Also read: China's lowest growth for 25 years: what does it mean?

Add to all of this the still super-stimulatory stance of monetary policy around the globe and the disjunction between markets and the real economy is obvious.

For investors losing the shirt off their back, that is cold comfort.

The market falls for those holding stocks are substantial and will, as we saw with the Westpac Melbourne Institute of consumer sentiment release, dampen confidence.

Those consumers might be happier next month when they see the savings to them from lower petrol prices.

Over any reasonable time, markets do reflect the state of the economy.

Seldom, if ever, do stock markets sustain a fall when there is strong economic growth, nor rise when an economy is in recession.

Which is another way of saying that the current market turmoil is unlikely to persist as the economic expansion feeds into corporate earnings and profitability.

Also read: India to step up as China slows: minister

The catalyst for a change in market sentiment is not clear. It may be the US Federal Reserve pushing back the next rate hike in the cycle, of more closures of mines from resources companies which will cut supply and boost prices for commodities.

Suffice to say, irrational price action in financial markets does occur from time to time, and what we are witnessing in recent weeks is a prime example of that.

It can be nerve wracking to witness such moves, but for investors with a medium to long term time horizon, it might be prudent to look away for few weeks and wait for common sense to return.

 

Stephen Koukoulas is a Yahoo7 Finance expert with 

more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks, and as economic advisor to the Prime Minister of Australia.