What Made This Summer Different
As the summer comes to an end, I'd like to try something unusual, if I may. Let's collectively specify three major lessons that we learned about financial markets in the last two months and, after compiling a summary of them, draw out the implications for what lies ahead.
Below I list my three. Please feel free to offer others as you see fit. I will consolidate the submissions and publish a brief summary, along with an attempt to point to major areas of agreement and disagreement.
No. 1. Extremely resilient markets: Time after time this summer, markets brushed aside unanticipated shocks that would have normally resulted in notable and prolonged price declines. From multiple geopolitical threats, including those that could easily tip Europe into recession, to broad-based global economic weakness involving both advanced and emerging countries, markets repeatedly found a way to bypass the damage.
Investors seem to have taken comfort in two factors. First, the steadfast support of central banks that are bolstering financial markets as a way to achieve their economic objectives; and doing so despite the mounting risk of future financial instability. Second, the beneficial impact of large fund inflows, not just from underinvested individual investors but, importantly, from companies putting their large piles of idle cash to work via higher dividend payments, share buybacks and acquisitions.
No. 2. Shifting correlations: Unusual and changing correlations overwhelmed historical relationships that still underpin most asset-allocation models. At times, all markets moved nicely together this summer, boasted by investors' faith in the ability of central banks' use of liquidity to lift all financial assets. At other times, equities decoupled, doing well while other asset classes experienced some isolated stress. And volatility in almost every market remained low and well-behaved.
No. 3. Central bank signaling: At times this summer, the signals coming out of central bankers were reminiscent of one of the most-repeated lines in "Gravity," the hit movie about outer space: "Houston in the blind," a phrase used by American astronauts to signal that they weren't receiving a response to their radio transmissions. Yet markets behaved as if central banks had all the needed answers.
Once again this summer, economic growth and inflation fell short of central banks' projections, both in the U.S. and in Europe. At the same time, officials acknowledged the difficulties they faced in measuring concepts that are critical to assessing current and future policies, such as the amount of labor market slack. These shortfalls have started to be reflected in greater policy divergence among central banks and, also, among policy makers within individual banks (including the Federal Reserve and the Bank of England).
Those are my three points. Now it's your turn to share what you see as this summer's major lessons. Please use the comment section if you are so inclined. Thank you very much.
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