It all sounded so great. The exuberance at the World Economic Forum’s Davos meeting was eerily reminiscent of 2006, which worried many analysts. Then it happened: A higher-than-expected wage growth spooked the markets who were fearing the re-emergence of inflation and more than the expected three rate rises by the Federal Reserve (Fed) this year. It was always a question of how to wean expectations off the drug of combined low interest rates and expansionary monetary policies.
Both the Fed and the European Central Bank are shrinking their balance sheets; and the Fed is raising rates. It was not a matter of if, but when there would be a wake-up call.
The ferocity and velocity of this wake-up call stunned markets. The last two weeks saw $4 trillion wiped off global stock markets in as little as two days.
Up to Feb. 2, equities lived in a sustained goldilocks environment and volatility was all but gone. It came back with avengeance with the volatility index VIX reaching 51 at times. (The multi-year average for the VIX stands at 20.) While this was a correction and not necessarily a crisis, the movements of global stock markets were exacerbated by computer-led exchange-traded mechanisms. They reacted vehemently to the spikes in volatility.
We will still have to get used to the new normal, which is the end of cheap money and expansionary monetary policies on both sides of the Atlantic. Such adjustments are never easy. Therefore volatility is back, which in itself is not necessarily a bad thing.
We must get used to the end of cheap money and expansionary monetary policies on both sides of the Atlantic.
There was little attention focused on what this new normal will mean for emerging markets. Although the S&P 500 was down by around 10 percent, the i-shares of the MSCI Emerging Markets Index were down by 12 percent.
This is a large drop. We still have not seen the magnitude of outflows from emerging markets which we witnessed during the “taper tantrum” of 2013, when tightening noises from the Fed opened the floodgates from emerging markets assets and currencies.
The reason is simple: Many emerging markets have reduced their reliance on the US, which is why the stock markets reacted badly while the currencies held relatively stable.
Emerging markets underperformed between 2010 and 2016 and have finally rebounded. The earnings outlook is positive and the economies are set to grow. As most of them are export-driven, the trajectory of the global economy in general, and China in particular, will matter greatly.
As for the GCC economies, the stock market indices are all down to varying degrees. The sovereign wealth funds will have been hit heavily by the turmoil. However, they are wise, long-term investors who can navigate the vagaries of the markets without getting spooked.
Most of the GCC economies other than Dubai are still based on oil and highly correlated to oil markets. The success of the OPEC/non-OPEC deal to restrict production and the subsequent rise in price has done wonders for their government investment programs, which are important in that part of the world.
Brent is no longer flirting with $70 and has readjusted to somewhere between $60 and $65. This is still way above where we were two years or even one year ago. It means that the GCC governments’ investment programs might still be reasonably on track, which is good news for the economy. All in all the fundamentals for economies based on oil do not look bad as long as demand is set to grow and the OPEC/non-OPEC deal holds. There will be volatility, but that is the new normal.
• Cornelia Meyer is a business consultant, macro-economist and energy expert.