WORLD STOCK EXCHANGES: THE "GREAT CORRECTION" HAS STARTED

WORLD STOCK EXCHANGES: THE "GREAT CORRECTION" HAS STARTED

How long will last the panic attack? After Lehman, is the giant bull market over? The bull market in world stock markets did not finish yet, but a large correction lasting in October is quite possible. As far as the terminology is concerned, when the stock market loses more than 20% from its peak, it indicates that it's a bear market whereas a 10-20% loss of value is a "correction".

On Friday, the leading world stock markets continued with their bloodbath. S&P 500 and MSCI World Stock Index had lost value this week by 3.1% and 2.7%, respectively.  World stock markets saw a fortune of $ 3.5 trillion melt. According to data from research firm EPFR, all the investors fled from riskier assets to the Money Market Funds by placing $ 47 billion. The VIX index which is considered a risk indicator for the world stock markets, jumped by 13% on Friday to attain 21.24 by not only reaching the summit of the year but also went above of the long-term average of 20.

The wave of selling was initiated by the dark prognostics of the IMF. The Fund revised down its growth forecast for 2014 and 2015, while the Eurozone (EB) recession and inflation risk were found to be 40%. The President Lagarde has deepened the fears by anticipating lower growth in the coming years. The decline in the oil prices, China's gradual slowdown and the confusion in respect to the steps to be taken by the Fed and the ECB on the matter of the monetary policies have contributed to the wave of selling.

Let's start from the Fed. FOMC minutes and Labour Market Demand Index, published twice a month came low and most probably in the meeting which will take place in the end of this month, the sentence of "low interest rates for a long time," will remain in the text for a long time. But there isn't much support to the FOMC's view regarding the strong dollar and the slowdown in the world economy will force the economy to stop. On the contrary, the declining loan rates and accelerating employment could quite possibly permit the economy to grow by 3% or be stabilized in a faster pace. On the other hand, it is also possible that a strong dollar would cause a collapse in the commodity markets by combining with inflationary pressures. The investors do not know how the Fed will behave in the midst of opposing winds, the contradictory statements coming from the governor raises uncertainty.

As fas as the ECB is concerned, Draghi is fearing as much as does IMF about the scourge of recession-deflation. The President wants to start an excellent QE by buying asset backed securities together with government securities but Berlin is opposed to this. The concerns regarding ECB doesn't have enough ammunition against the deepening of the recession have brought heavy losses in the stock markets of the Eurozone this week.

Now let's look to the future. In the past, this kind panic attacks were very short-lived because of the perception that central banks will engage rapidly would cause purchases first in the F/X market and the credit market, then in the stock market. This time, there is the perception that the Fed and the ECB will not rush to the aid, even if they rush, printing money will no longer support the economies which in turn suggest that the sales will continue for some time.

The world economy is not as bad as IMF described; on monthly basis,  the JP Morgan Global and HSBC Emerging Markets (GOI) PMI which measure the strength of the economic activity, have reported that during summer the activity remained flat at a moderate pace. The Chinese government repeated that it would take selective budget measures against the economic slowdown on Thursday. It is also possible that the Bank of Japan may soon undertake an additional monetary expansion.

On the negative side, other than the United States, there aren't any nice stories that could attract investors to take risks. All over the world, corporate profits have slowed down; the geopolitical risks in many developing countries and internal political conflicts are disturbing. Finally, the increase in volatility and the IMF's warning about the bubble forming in the private sector bond market have led to the loss of appetite in the leveraged positions.

In order to have the elimination of the pessimism, in the meeting to be held before the end of the month the Fed must take steps to eliminate uncertainty in its monetary policy, then one would need to see the recovery in the data from the world economy or certain main countries. In the end, the P/E ratios other than S&P 500 are quite low; if the sales prevail, the long-term fund looking for bargain issues will start to buy. It is quite possible that this correction will continue until the MSCI World Stock Index drops 5% more. The losses in risky markets such as Turkey can be a little bit more.