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).
By Mohamed A.El-Erian, originally published in Bloomberg View on 8/25/14. Reprinted with permission. The opinions expressed are those of the author.
