The world economy is in precarious shape.The Asian crisis is expected to cut growth by over one third in 1998. The Japanese economy will contract by at least 1 per cent, prolonging the slump throughout the East Asia region, despite the big expansion package put in place in Tokyo. The risks of Chinese devaluation have risen sharply, as the yen remains weak and the trade balance of Beijing worsens. The best performing economies of recent years, those of the US and the UK, have started to cool off rapidly. Only Europe is showing signs of robust growth, in the order of 2.5 per cent, with confidence boosted by the prospective birth of the euro as a new currency on 1 January, 1999.
Despite all these uncertainties, western stock markets, generally held to be a reliable indicator of economic confidence, have held up remarkably well. On Wall Street, share prices, led by the technology and telecoms stocks, are at record levels and show few signs of faltering.
Even Continental Europe has discovered the value of equity investment. The Deutsche Borse in Frankfurt is increasingly establishing itself as a global-class equity market as a result of privatisations such as those of Deutsche Telecom and Lufthansa and the increasing tendency of medium-sized enterprises to seek share quotations.
Amid all this optimism only the Asian markets are suffering, with Japan's Nikkei reduced to almost half the peak level of the late 1980s.
The current confidence in equity markets, together with improving technology and the advance of the euro area, is leading to an increasing number of alliances among stock markets. The same globalisation of activity and formation of co-operative agreements which has been seen among airlines in recent years, is now happening among global stock markets. The London Stock Exchange (LSE) and the Deutsche Borse have formed an alliance and plan jointly to trade 300-400 of Europe's top shares - including the leading air carriers - as part of a new European-wide index.
In the Western US, the Pacific Exchange, which has traditionally looked towards Asia, has linked itself to the MidWest through the Chicago Board Options Exchange, the biggest market in derivative financial products in the world. These alliances and the effort by Nasdaq to forge relationships in Europe - it has held negotiations with the Deutsche and Paris bourses and the LSE - suggests that we could not be far away from the first world stock market - all of which may seem like good sense in an age of transnational corporations and alliances.
But it has its dangers, particularly when equity markets appear as overvalued as they are now in the West. Structural changes in savings vehicles, such as the development of do-it-yourself pension plans in the US, personal equity plans in the UK and the growing preference for equity investment in Germany, have changed for ever the patterns of stock market growth. During the time that wall of cash from savers is moving into shares, rather than cash and bonds, share markets will be healthy. Alan Greenspan, chairman of the US Federal Reserve Board, took on these theories in his mid-year testimony to Congress in July. He argued that there was no evidence to suggest that the historical pattern of a bull market in shares followed by a bear market had been eliminated.
In the past, major market movements, both up and down, have been caused by a switch in the direction of interest rates or an economic shock of some kind. The stock market setbacks of the 1970s were largely the result of successive oil crises after the Yom Kippur war and the Iranian Revolution. The 1987 crash was preceded by a dispute over the direction of interest rates between the US, which wanted no increases, and Germany which did. Many analysts believe that the trigger for the next correction will be a rise in US interest charges.
American rates have been held at an artificially low level for much of the past year as US policymakers remained reluctant to raise interest rates in the face of economic uncertainty in Asia. The UKNational Institute for Economic Research believes that US consumer price inflation will start to surge in 1999 and that the Federal Reserve will anticipate this by changing its current interest rate stand. Another possible trigger is a further deterioration in the Japanese banking system.
Should business be worried by such developments? Very much so. In the first instance, falling stock markets shatter confidence and lead business people to postpone investment decisions. An airline would not consider pressing ahead with options on new aircraft in the face of a stock market crash. Moreover, in that a bear market also presages a decline in economic activity, it could well mean that the peak in the profits cycle for air carriers has also been reached. But there are financial effects too. Falling share values make it almost impossible to raise new cash through a rights issue or an initial public offering. Companies can be forced to take on extra debt, the cost of which is higher because of the uncertainty in equity markets.
Moreover, no one is quite sure how the next stock market correction will play itself out. The introduction of new financial products like derivatives theoretically makes markets more stable. But, in late 1997, when problems in Hong Kong temporarily sent Wall Street and London tumbling, the downward shift in prices was more sudden and uncontrolled than expected. The increasing globalisation of equity markets has not yet been matched by an international structure of regulation, designed to stabilise matters in times of crisis. This mismatch between market mechanics and emergency procedures is more exposed with each new stock market alliance that is forged.
Source: Airline Business
