It’s been a gloomy couple of days for stock markets.
The Dow Jones index saw its worst fall in a long time on Wednesday, tumbling near-enough 300 points. It closed lower yesterday too. Most of the rest of the world’s stock markets have been following suit.
So what’s spooked investors?
The main worry is that economic growth seems to be slowing across the world. From Beijing to Chicago to London, surveys carried out in May suggest that the manufacturing sector is heading back into the doldrums.
Why the slowdown? And what does it mean for your investments?
The real culprit behind the slowdown – inflation
Why is manufacturing going into a slump across the globe? There’s one very obvious answer that springs immediately to mind: it’s all down to Japan.
The earthquake and tsunami have played havoc with global supply chains. A ‘just-in-time’ world has major problems coping with disruption on this scale. As several pundits noted in the wake of the disaster, you might source 99% of your parts from outside Japan, but a car can’t go out with just 99% of its parts present and correct.
It’s a compelling explanation. But it’s not the main one.
The Japanese disaster has had some impact, yes, says Andrew Kenningham of Capital Economics. But “the index of global suppliers’ delivery times is now back to the level recorded at the beginning of the year”. In other words, goods are getting through when they’re needed.
More to the point, the Japan disaster can’t explain the fact that there’s been a corresponding fall in global service sector activity.
Indeed, if you exclude Japan from the mix (the country actually saw manufacturing activity rebound sharply in May, although this doesn’t include the earthquake-hit areas) then global manufacturing activity is at its weakest since August 2009.
Kenningham reckons that the real problem is that “higher commodity prices are adversely affecting household consumption”. In other words, with the cost of fuel and food rising, people don’t have the money left over to buy anything else.
This is a serious problem. As my colleague David Stevenson pointed out yesterday, it could have a major impact on the UK housing market too.
The Fed may keep us waiting for QE3
What does it all mean? The assumption has been that if there’s a slowdown then the US will step in with more money printing. Quantitative easing part three (QE3) will set sail and bail everyone out with cheap money again.
There’s every chance that this will happen. The slide in US Treasury yields in recent days suggests that investors certainly expect someone with a lot of money to be stepping into the market in the near future. That’s one reason why we’re hanging onto gold very tightly indeed.
But as I’ve said before, QE3 won’t be as easy to get off the ground as QE2. If we need yet more QE, after all, the immediate question is: why did QE2 fail to make the US recovery self-sustaining? And if QE2 failed, should we really be doing more of the same now?
Also, Americans are becoming increasingly aware of their country’s huge debt problem. Now another ratings agency – Moody’s – is warning that if the US doesn’t stop squabbling over its debt ceiling, then it could lose its AAA-credit rating.
As American voters steadily become more concerned about the state of their country’s balance sheet, they’ll be less accommodating of more government spending and money printing. Just as British voters backed austerity before the election (regardless of how they feel about it now), US politicians may decide that QE3 isn’t a vote winner.
That would leave Fed-dependent markets in an interesting position. It would take quite a plunge in prices to convince people that QE3 was justified.
So what does all this mean for investors?
As well as our usual mix of defensive plays and gold, I mentioned a few weeks ago that a play for the more adventurous might be to short the Aussie dollar. Since then, the Aussie has fallen from around US$1.10, to closer to US$1.07. But I think it’s got further to go.
Australia’s economy is basically a play on Chinese demand. If China’s economy slows, then Australia’s is in trouble. Obviously there are many other ways you could play slowing Chinese demand, but this one strikes me as one of the most intuitive.
Meanwhile, if QE3 doesn’t materialise, or investors become even more concerned, then the dollar would likely rally from today’s historically low levels.
Of course, spread-betting currencies is not for those who like a quiet life. You can lose more than your initial stake, Timing your trade also isn’t easy, as I’ve learned to my cost on a few occasions.
But if you are interested, you should sign up for the free MoneyWeek Trader email. Veteran trader John C Burford gives his tips and tactics on minimising losses and maximising profits. I’ve found John’s advice to be very helpful, particularly his constant reminders about disciplined money management. You can sign up for MoneyWeek Trader here.
Our recommended article for today
Corporate data-collection is theft
Every day, corporations store more and more details about our lives. But their massive data-collecting spree is a form of theft, says Matthew Lynn. The information belongs to us as individuals. And companies who are collecting it are stealing from us.