By Malcolm Maiden
Earlier this week I wrote that the markets appeared to be at another crash through or crash moment, and that is still the case.
Last night's plunge was scary, but it was on the back of indecision about what is happening to the world's economy, rather than a definite view that the battle to pull the global economy out of hole it dug for itself in the 2007-2009 financial crisis has been lost. From here the markets could bounce or fall a lot further, depending on what the verdict is.
There's certainly a lot to worry about, and the market dive that has in the last five trading days seen Wall Street shares lose about about 6 per cent of their value, European shares lose about 5 per cent and Australia's market fall by more than 3 per cent to be around 10 per cent, 25 per cent and 16 per cent down respectively, so far this year comes amid a welter of gloomy news.
It includes Italy's sovereign debt downgrade, downgrades for the big US commercial banks, Bank of America, Wells Fargo and Citigroup, reduced IMF world growth estimates, an attempt by the US Federal Reserve to stimulate the American economy by pushing down longer-term rates that really only serves to show how weak its remaining levers are, and some signs that growth could be slowing in China (the last remaining global growth engine that is firing on all cylinders).
Also, continuing indecision in Europe, firstly about whether or not to formally recognise that Greece is insolvent and what the consequences of Greek sovereign bond default would be, and Italy's vulnerable economy and a $1.8 trillion debt funding burden in particular.
There's some mystification here that our market and our our currency should slavishly follow the rest of the world down, but the local share sell-off and the descent of the Australian dollar to below parity with the US Dollar reflects the inescapable fact that the event that the markets are worrying about is a global recession, and a global recession would not pass Australia by.
Our economy is one of the most open in the world, and that means we will always import overseas conditions, through our commodity trading channels primarily. And commodity prices are falling because traders figure that slower world growth means lower demand for commodities.
Where to from here?
Bad economic news and more ratings agency downgrades (a 50-50 chance), would prompt more selling but the markets should not collapse: something very close to recession is now priced in.
If Greece's bale out funding is extended, the markets could bounce, but only by a few per cent, because Greece will still be insolvent, and the the markets will know the existential question will return in the New Year, perhaps earlier.
And if the European Union, The IMF and the European Central Bank take a deep breath and allow Greece to default, the big moment will have arrived. The markets would plunge on the day it occurred.
But if in a few days the Italian and Spanish bond markets had not collapsed - central bank buying would be needed to prevent it, almost certainly - the circumstances for a major rally would exist because the threat of a return to global crisis mayhem would be removed (the longer term problem of rebuilding western world economic growth to a point where the west can began paying down its maxed-out sovereign debt credit card would remain, however, so pre-global financial crisis prices would not return).
The nightmare scenario is that Greece is allowed to default, and European lawmakers and regulators then lose control of the situation.
This market is still 25 per cent above its March 2009 global crisis low. An uncontrolled European bond market selloff on top of the all the other negative indicators would retest that crisis nadir.
mmaiden@theage.com.au