Financial Update 8-14

Last month the Federal Reserve warned that the values of some stocks and junk bonds were starting to look inflated, a move that many took as meaning the long-running bull market might be starting to run out of steam. This week it’s starting to look as if they were right. Growing wariness of junk bonds has turned into a much wider sell-off that’s seen a whole array of industry benchmark stocks drop sharply. The CBOE Volatility Index – widely known on Wall Street as the “fear gauge” – hit its highest level for nearly four months as more risk-averse investors started moving their money to US Treasuries and other safe havens like gold. However it’s still not clear if the bull run has really come to an end or if other factors are causing a sell-off that could reverse itself in a few weeks.

The main trigger for last week’s selling was worry about how the international situation is going to impact on the global economy. With the crises in Ukraine and Iraq showing no signs of ending any time soon, and Israel locked into the latest instalment of its endless war in Gaza, there’s a lot of uncertainty at present. Although energy prices are stable right now there are still concerns in Europe about what will happen if Russia’s huge gas reserves are affected by sanctions when winter starts to draw in. It goes without saying that any trouble in the Middle East has the potential to push the cost of oil sharply upwards.

Some investors are also wondering if this is just a touch of late-summer volatility with no real substance behind it, instead of a real adjustment in the market. However the worry on Wall Street is very real; Standard & Poor’s 500 index was stagnant this period, finishing 0.3 percent up on last week – but still a whole 3 percent down from July’s record high. It would have been down again but US strikes against Iraq’s ISIS insurgency gave it the push it needed to take back the week’s losses. It still wasn’t enough to calm the rush to US Treasuries, with 10-year notes now down to the lowest yield of the year at 2.37 percent.

The jitters aren’t confined to the USA, with the Tokyo exchange falling 3 percent on Friday and the London indexes at their lowest levels for up to four months. European bank equities have been hit particularly hard and the tit-for-tat sanctions between Russia and the EU are unlikely to boost confidence. EU Central Bank president Draghi is now warning that the tense international situation could halt the Eurozone’s recovery in its tracks, and if that happens the effects are guaranteed to cross the Atlantic. Analysts are pointing to the sanctions against Russia as a serious block to resumed growth but political inertia means they’re not likely to be lifted soon.

This week has shown that the recovery in the US isn’t a lot more robust than that in the Eurozone, and investor confidence isn’t high. However if you’re willing to take some risks there are still some great deals to be had, with high-yield bonds at very attractive prices. It might not be time to run for safety just yet.