tag:theconversation.com,2011:/id/topics/ftse-100-15197/articlesFTSE 100 – The Conversation2022-02-21T15:24:12Ztag:theconversation.com,2011:article/1775062022-02-21T15:24:12Z2022-02-21T15:24:12ZStock markets have been a one-way bet for many years thanks to the ‘Fed put’ – but those days are over<p>The prospect of a Russian invasion of Ukraine have sent the markets into a tailspin, compounding fears around inflation that have been building over the past few months. The S&P 500 is trading at 10% below its recent all-time high, while the Nasdaq is down by over 16%. </p>
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<p>The markets have been inflated for years by very easy monetary conditions in which interest rates have been ultra-low and central banks have been “printing money” in the form of <a href="https://www.bankofengland.co.uk/monetary-policy/quantitative-easing">quantitative easing</a> (QE). But one additional factor that has encouraged investors to put so much money into the markets is the so-called “<a href="https://faculty.haas.berkeley.edu/vissing/cieslak_vissingjorgensen.pdf">Fed put</a>”. This is the idea that the US Federal Reserve (and other central banks) will not allow the markets to fall beyond a certain threshold – say 20% to 25% – before riding to the rescue with lower rates and more QE. </p>
<p>Such is the debt in the global financial system, goes the logic, that the markets cannot be allowed to fall any further. A bigger drop could set off a chain reaction of bad debts that could destabilise the biggest banks and cause a crisis that would make 2008 look mild. </p>
<p>Known as <a href="https://www.investopedia.com/options-basics-tutorial-4583012#:%7E:text=Call%20and%20Put%20Options,-Options%20are%20a&text=If%20you%20buy%20an%20options,right%20to%20sell%20a%20stock.">a “put”</a> in reference to a financial instrument that options traders buy to protect themselves from a fall in the markets, the argument is that markets are effectively a one-way bet. Certainly, the S&P 500 has risen sixfold since 2009 and the Nasdaq 12-fold as central banks have eased monetary conditions repeatedly. Even the under-performing FTSE 100 is up by two-thirds over the same period. </p>
<p>We would argue, however, that the Fed put no longer exists. Let us explain why. </p>
<h2>The put in action</h2>
<p>The idea emerged when <a href="https://www.federalreservehistory.org/people/alan-greenspan">Alan Greenspan</a> was chair of the Federal Reserve. Starting with the Black Monday crash of autumn 1987, Greenspan became known for cutting the federal funds interest rate to improve investor sentiment when markets dropped significantly. This was a big shift from the Fed’s previously very slow and cautious approach to changes in the business environment. </p>
<p>When Greenspan cut aggressively after the dotcom crash in the early 2000s, it helped to inflate the US subprime housing bubble that precipitated the 2007-09 crisis. During that crisis, the <a href="https://www.federalreserve.gov/newsevents/speech/bernanke20090113a.htm">Fed’s response</a> – now under Ben Bernanke – was again to cut rates and also to increase the money supply through QE. This extra money encouraged financial institutions to lend to businesses and consumers to haul the wider economy out of recession, and <a href="https://www.brookings.edu/wp-content/uploads/2016/06/11_origins_crisis_baily_litan.pdf">lend more</a> to traders so that they could plough it into the markets. </p>
<p><strong>Federal Funds rate 1972 to present</strong></p>
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<a href="https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Federal Funds rate over time" src="https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=260&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=260&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=260&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=327&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=327&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447501/original/file-20220221-14-ywm2k0.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=327&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://tradingeconomics.com/united-states/interest-rate">Trading Economics</a></span>
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<p>The effect of this QE was to expand the <a href="https://www.bankrate.com/banking/federal-reserve/federal-reserve-balance-sheet/">Fed’s balance sheet</a> (in other words, its assets and liabilities) after years of being flat at around US$1 trillion (£733 trillion) to a peak of <a href="https://www.brookings.edu/blog/up-front/2019/05/17/the-feds-bigger-balance-sheet-in-an-era-of-ample-reserves/">US$4.5 trillion</a> in 2014. The Fed then <a href="https://www.ecb.europa.eu/pub/conferences/ecbforum/shared/pdf/2014/ferguson_paper.pdf">very slowly</a> began unwinding these holdings and raising the Fed funds rate from 0.25% to 2.5%, but after a sharp 20% fall in the S&P 500 in late 2018 (and also a drop in government bond prices), it started cutting rates again. </p>
<p>The Fed did continue unwinding QE in the first half of 2019, getting its balance sheet below US$4 trillion. But it went into reverse later in the year after a spike in the crucial <a href="https://ig.ft.com/repo-rate/">“repo” rate</a> at which banks lend funds to one another overnight, which prompted concerns about the prospect of another 2008-style panic. </p>
<p>In March 2020 as the global economy shut down in the face of the <a href="https://www.nytimes.com/2021/02/26/opinion/sunday/coronavirus-alive-dead.html">COVID pandemic</a>, the Fed then swung into full rescue mode. It announced the most aggressive QE programme to date to support the economy, and the balance sheet ballooned to nearly <a href="https://www.ft.com/content/9af75cb4-9743-41af-896f-f25d7588d323">US$9 trillion</a> by late 2021. </p>
<p><strong>Federal Reserve balance sheet</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Fed balance sheet over time" src="https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=363&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=363&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=363&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=456&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=456&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447500/original/file-20220221-26-24vjj6.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=456&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://www.statista.com/statistics/1121448/fed-balance-sheet-timeline/">Statista</a></span>
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<p><a href="https://www.gla.ac.uk/media/Media_219105_smxx.pdf">The result</a> of all this easing has been a huge surge in asset prices – not only stocks and bonds but also property. Though <a href="https://www.marketplace.org/2021/03/03/did-the-federal-reserve-make-economic-inequality-worse/">it’s difficult</a> to estimate the effect, the wealthiest 10% in the US now own over 60% of assets, while the poorest 50% own less than 6%. </p>
<h2>The situation now</h2>
<p>The recent falls in stock markets (and bond markets) are taking place while the US economy is performing well. It grew by nearly <a href="https://www.ft.com/content/d44294d5-879d-4013-a79e-82f117b805c5">6% in 2021</a> despite the pandemic. The labour market is robust and <a href="https://www.vox.com/2019/3/18/18270916/labor-shortage-workers-us">lower-skilled workers</a> are finding new opportunities with higher wages. </p>
<p>Yet <a href="https://www.conference-board.org/topics/consumer-confidence">consumer confidence</a> is low, which is partly <a href="https://www.bls.gov/cpi/">due to inflation</a>. Consumer prices in the US rose by a <a href="https://www.bls.gov/opub/ted/2022/consumer-prices-up-7-5-percent-over-year-ended-january-2022.htm">staggering 7.5%</a> over the 12 months to January 2022, the largest since the early 1980s, while the situation has been <a href="https://www.theguardian.com/business/2022/feb/16/uk-inflation-rises-amid-cost-of-living-crisis">similar elsewhere</a>, including in the UK. </p>
<p>The big fear is that workers begin demanding equivalent pay rises in response. This could cause a <a href="https://www.economist.com/leaders/workers-have-the-most-to-lose-from-a-wage-price-spiral/21807722">wage-price spiral</a> in which producers further raise their prices to pay for higher wages, sparking further wage demands and so on – essentially making inflation a <a href="https://theconversation.com/inflation-why-it-is-the-biggest-test-yet-for-central-bank-independence-173676">longer-term problem</a>. </p>
<p>The Fed is tightening monetary conditions to try and get inflation under control: paring back QE to end in March with a view to beginning to reduce the balance sheet later in the year, and signalling that <a href="https://www.forbes.com/sites/jonathanponciano/2022/02/16/stocks-keep-struggling-after-fed-minutes-signal-march-interest-rate-hike-still-on-track/">the federal funds rate</a> will start going up from its current 0.25% in March. </p>
<p>When central banks tighten in this way, it tends to cause economic slowdowns <a href="https://www.wsj.com/articles/behind-the-feds-slow-pivot-to-tackling-inflation-11644930180">and recessions</a>. Together with the prospect of less QE money available for traders, this helps to explain why the markets have been going down. The question is what happens if the markets fall much further: will the Fed and other central banks keep tightening or go into reverse? </p>
<p>There’s a big variation <a href="https://www.bloomberg.com/news/articles/2022-01-29/goldman-sachs-predicts-fed-will-raise-rates-five-times-this-year">in expectations</a> about interest rates, which indicates that nobody is sure. In our view, the Fed and other central banks are likely to tighten fairly aggressively – in line with what the current Fed chair, Jay Powell, <a href="https://www.ft.com/content/c556a131-951d-4283-9e10-36becf77579f">has been signalling</a>. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Lots of cartoon men and a compass with financial crisis on it" src="https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=420&fit=crop&dpr=1 600w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=420&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=420&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=528&fit=crop&dpr=1 754w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=528&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/447541/original/file-20220221-16-srsh64.jpeg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=528&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Investors should not be resting easily.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/financial-crisis-words-on-pocket-watch-553762525">Light and Dark Studio</a></span>
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</figure>
<p>This time is likely to be different for several reasons. Inflation has never before been an issue during the era of the Fed put. It risks seriously damaging the Fed’s credibility, not to mention impoverishing ordinary people with potentially grave political consequences. </p>
<p>The financial system is also very different to in 2008. Whereas part of the problem during the global financial crisis was banks with too little capital to protect themselves, the system is <a href="https://eur01.safelinks.protection.outlook.com/?url=https%3A%2F%2Fblogs.worldbank.org%2Fallaboutfinance%2Fbank-regulation-and-supervision-decade-after-global-financial-crisis&data=04%7C01%7Ce.t.jones%40bangor.ac.uk%7C18307e2a20834d63b3ce08d9f4a28dab%7Cc6474c55a9234d2a9bd4ece37148dbb2%7C0%7C0%7C637809801262885395%7CUnknown%7CTWFpbGZsb3d8eyJWIjoiMC4wLjAwMDAiLCJQIjoiV2luMzIiLCJBTiI6Ik1haWwiLCJXVCI6Mn0%3D%7C3000&sdata=d%2BIpbAzshlV97oYRUv4ABqW%2FdUJE5J9GoNrSMG2CEjk%3D&reserved=0">better regulated now</a>. </p>
<p>At the same time, the pandemic has also been a very different economic crisis to other recent ones. Most recent crises, including 2007-09, were caused by problems within the financial system – what economists refer to as an “<a href="https://www.wider.unu.edu/publication/covid-19-really-exogenous-shock#:%7E:text=Endogenous%20shocks%20arise%20from%20within,from%20within%20the%20economic%20system.&text=A%20truly%20exogenous%20shock%20would,the%20tsunami%20in%20its%20wake.">endogenous shock</a>”. Something external such as a pandemic is an “exogenous” shock, and these tend to be quickly absorbed by healthy financial systems, with growth resuming smoothly once the disruption ends. </p>
<p>Raising rates and winding down QE should be <a href="https://eur01.safelinks.protection.outlook.com/?url=https%3A%2F%2Fwww.ft.com%2Fcontent%2F9c153d31-6f59-43f9-b7b2-8ba269b645dd&data=04%7C01%7Ce.t.jones%40bangor.ac.uk%7C18307e2a20834d63b3ce08d9f4a28dab%7Cc6474c55a9234d2a9bd4ece37148dbb2%7C0%7C0%7C637809801262885395%7CUnknown%7CTWFpbGZsb3d8eyJWIjoiMC4wLjAwMDAiLCJQIjoiV2luMzIiLCJBTiI6Ik1haWwiLCJXVCI6Mn0%3D%7C3000&sdata=Gpo5EstE5EsnZVwEKnyhBv4GbZT8nyL796728ToZIcM%3D&reserved=0">much more achievable</a> with today’s healthy, properly functioning financial system. It is therefore much less likely that the central banks will rescue the financial markets from a crash by U-turning on tightening out of fear that the system won’t cope. </p>
<p>How far markets fall as the economy slows down depends on many things, not least the <a href="https://eur01.safelinks.protection.outlook.com/?url=https%3A%2F%2Fedition.cnn.com%2F2022%2F02%2F18%2Feurope%2Fukraine-russia-conflict-explainer-cmd-intl%2Findex.html&data=04%7C01%7Ce.t.jones%40bangor.ac.uk%7C18307e2a20834d63b3ce08d9f4a28dab%7Cc6474c55a9234d2a9bd4ece37148dbb2%7C0%7C0%7C637809801262885395%7CUnknown%7CTWFpbGZsb3d8eyJWIjoiMC4wLjAwMDAiLCJQIjoiV2luMzIiLCJBTiI6Ik1haWwiLCJXVCI6Mn0%3D%7C3000&sdata=r9SHQ8zG%2FBccQRmVn7uWC%2FdEq477pY%2FTBnORkT%2FCtVk%3D&reserved=0">Ukraine-Russia conflict</a> and the path of inflation. But with the Fed put arguably no longer in play, everyone from pension holders to retail investors should tread very carefully.</p><img src="https://counter.theconversation.com/content/177506/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A market crash may be more likely than at any time in a generation.Edward Thomas Jones, Lecturer in Economics, Bangor UniversityYener Altunbas, Professor of Banking, Bangor UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1563262021-03-02T16:01:07Z2021-03-02T16:01:07ZWomen in boardrooms: after ten years of equality drives, it’s time for quotas<figure><img src="https://images.theconversation.com/files/387239/original/file-20210302-17-pf3l9n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/portrait-female-business-executive-sitting-alone-144904978">Sirtravelalot</a></span></figcaption></figure><p>The push to more fairly represent women in UK boardrooms is making good progress, according to the <a href="https://ftsewomenleaders.com/targets-progress/">final report</a> of the independent Hampton-Alexander review. The boards of the UK’s largest 350 listed companies were at least 33% female on average by the end of 2020, in line with the review’s headline target.</p>
<iframe id="noa-web-audio-player" style="border: none" src="https://embed-player.newsoveraudio.com/v4?key=x84olp&id=https://theconversation.com/women-in-boardrooms-theres-been-a-jump-forward-but-the-job-is-only-half-done-156326&bgColor=F5F5F5&color=D8352A&playColor=D8352A" width="100%" height="110px"></iframe>
<p>When the review was started in 2016 by former GlaxoSmithKline chair Philip Hampton and the late Helen Alexander, former president of business association the CBI, only 25% in the FTSE 100 and FTSE 350 boardrooms were female. And when the drive towards gender balance began in 2011 with former Labour minister Mervyn Davies’ <a href="https://ftsewomenleaders.com/2011-2015-the-davies-review/">predecessor review</a>, the figure was around 12% for the FTSE 100. </p>
<p>Hampton-Alexander has achieved this considerable success by getting businesses and other stakeholders to cooperate voluntarily. This has eclipsed efforts by most other <a href="https://ftsewomenleaders.com/">European nations</a>, many of whom resorted to quotas and punitive sanctions such as delisting or fines of companies or directors.</p>
<p>Continental initiatives tended to apply their targets of 30% to 40% female board membership to only 40 to 60 of the largest companies. Not only was the UK review’s group of 350 target companies much larger, it also went beyond board representation to set a 33% figure for women’s “leadership roles”. This had risen from 24% in 2017 to 30% by the end of 2020. </p>
<p>The UK review benefited from clear targets, transparent reporting, publishing relevant data and encouraging voluntary codes by executive search companies, investment companies and the Financial Reporting Council. The most severe sanction on non-compliant companies has been “naming and shaming”. So is it time for UK companies to congratulate themselves and start teaching other European countries how to do better? Not quite. </p>
<h2>Women and company performance</h2>
<p>The headline figure of 33% of women on company boards and in senior positions looks good. But if Bill Gates walks into a small bar in Nebraska, “the average person” is a millionaire. </p>
<p>Digging deeper into the data, 37% of FTSE 350 companies have not even hit the 33% target for women on boards and around 70% have not hit the 33% target for leadership positions. </p>
<p>Detractors might also say that finding a few hundred qualified women to achieve 33% representation on FTSE boards over ten years is the low-hanging fruit. Perhaps we need to judge the initiative against the original reason for which it was set up, namely to increase the talent pool of influential females in business with a view to increasing company performance and achieving equality in senior appointments. </p>
<p>When it comes to company performance, <a href="https://journals.aom.org/doi/10.5465/amj.2013.0319">the impact</a> of female board members turns out to be extremely difficult to pin down, partly because the average size of the board is quite small at around ten. Hence, you are trying to measure the impact on profitability caused by the addition of about three women. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/387240/original/file-20210302-13-hopfct.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Executives around the boardroom table" src="https://images.theconversation.com/files/387240/original/file-20210302-13-hopfct.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/387240/original/file-20210302-13-hopfct.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/387240/original/file-20210302-13-hopfct.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/387240/original/file-20210302-13-hopfct.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/387240/original/file-20210302-13-hopfct.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/387240/original/file-20210302-13-hopfct.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/387240/original/file-20210302-13-hopfct.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">It’s hard to show that more women = better performance.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/business-young-senior-people-group-working-1032709384">fizkes</a></span>
</figcaption>
</figure>
<p>Even then, given the many possible influences on company profits, the evidence suggests it is very unlikely you would expect to see a strong positive effect from this change <a href="https://academic.oup.com/qje/article-abstract/127/1/137/1832366?redirectedFrom=fulltext">even across</a> many companies and over many years. Even where you have a positive correlation between profits and female board representation, it might be because of highly profitable companies appointing more women, rather than more women making companies more profitable. </p>
<p>The case for more women in executive positions is therefore one of diversity and fairness and a presumption that “women do no harm” to the bottom line. </p>
<h2>Senior appointments</h2>
<p>Senior appointments are another matter. Greater visibility of women in top positions may well open up promotion pipelines and encourage other women’s aspirations to success in business, but there is not strong evidence that this has fully delivered yet. </p>
<p>Only 14% of full-time executives on FTSE 100 boards are women, so much of the rise will be part-time positions. Only 23% of women are “senior independent directors”, 11% are chairpersons of the board, and only 8% are full-time chief executives. The figures are broadly similar for the next 250 largest UK companies. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/387241/original/file-20210302-21-41geqa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Female conductor waves wand" src="https://images.theconversation.com/files/387241/original/file-20210302-21-41geqa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/387241/original/file-20210302-21-41geqa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=805&fit=crop&dpr=1 600w, https://images.theconversation.com/files/387241/original/file-20210302-21-41geqa.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=805&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/387241/original/file-20210302-21-41geqa.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=805&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/387241/original/file-20210302-21-41geqa.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1011&fit=crop&dpr=1 754w, https://images.theconversation.com/files/387241/original/file-20210302-21-41geqa.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1011&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/387241/original/file-20210302-21-41geqa.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1011&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Unbiased manoeuvres in the dark.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/orchestra-conductor-music-conducting-hands-baton-1045383370">Alenavlad</a></span>
</figcaption>
</figure>
<p>Women’s failure to secure more influential full-time roles may be because those making the appointments are unconsciously biased. This is difficult to prove, but there is some good evidence that it happens. For example, when <a href="https://www.aeaweb.org/articles?id=10.1257%2Faer.90.4.715&source=post_page-----deda93da109b----------------------">musicians audition</a> behind a screen, more women get selected for orchestras. </p>
<p>Similarly, the number of applicants who get called for job interviews <a href="https://www.aeaweb.org/articles?id=10.1257/0002828042002561">is much lower</a> among those with names associated with ethnic minorities than with white applicants, even though both sets of CVs are constructed to be equivalent and both are sent to the same firms. </p>
<p>The Hampton-Alexander review also did not examine if (the few) women and (many) men who successfully climb the executive greasy pole are treated equally when they reach the top. <a href="https://dash.harvard.edu/handle/1/25525846">In a study</a> of top earners in Swedish firms, 30% of male executives achieve chief executive positions compared with 12% of females. Also, male executives earn 27% more than female executives. </p>
<p>Hardly any of these huge differences can be explained by personal attributes such as educational attainment, past employment experience, marital status or number of children, or the type of firm or sector. Could this be explained by unconscious bias?</p>
<h2>What now</h2>
<p>The underlying findings and shortcomings in the Hampton-Alexander review demonstrate that it needs to continue, reinforced by continued government backing. It’s time to impose 33% quotas on straggler firms – including financial penalties on existing directors. </p>
<p>Achieving a “critical mass” of women in “influential positions” is still required. The female pipeline is now established, but the flow needs speeding up. New targets are needed so that more women are in executive director positions and the various other senior positions I mentioned. The work of the review could be combined with that of the <a href="https://diversityuk.org/recommendations-parker-review-published/#:%7E:text=The%20Parker%20Review%20Committee,%20led%20by%20Sir%20John,their%20employee%20base%20and%20the%20communities%20they%20serve.">Parker Review</a>, which is targeting at least one BAME member on FTSE 100 boards by 2021 (and by 2024 on FTSE 350 boards).</p>
<p>A caveat. The debate around Hampton-Alexander is largely about improving the careers of women in well-paid positions. Any further work must not detract from government policies that affect most women, such as parental leave, childcare provision, domestic violence, schooling, <a href="https://www.ifs.org.uk/uploads/publications/wps/wp201606.pdf">university</a> and career choices in business, government and other areas of the private sector. Finally, the impact of COVID-19 on <a href="https://api.includere.co/uploads/Stanford%20Research-How%20working%20from%20home%20works%20out%20-%20June%202020.pdf">flexible working</a>, a major driver of women’s advancement, needs investigation.</p><img src="https://counter.theconversation.com/content/156326/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Keith Cuthbertson does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Female representation on FTSE 100 boards has risen from 12% to over 33% in a decade.Keith Cuthbertson, Professor of Finance, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1455162020-09-04T10:38:48Z2020-09-04T10:38:48ZHas the FTSE 100 really performed as badly this century as it appears?<p>Apple <a href="https://www.theguardian.com/technology/2020/sep/01/apple-value-ftse-100-iphone-coronavirus">has become</a> the first company worth US$2 trillion (£1.7 trillion), meaning that it is now more valuable than all the companies in the FTSE 100 (they add up to £1.5 trillion). This is extraordinary news about one American tech company, but it also points to the fact that FTSE 100 share prices have performed poorly against rival indices around the world for several decades. As we shall see, however, it’s a more complicated story than it first appears. </p>
<p>If an investor had bought £1,000 of the shares of all the companies on the FTSE 100 on January 31 2001 and sold them on July 31 of this year, she would have lost £63.48, a <a href="https://www.stockles.com/2017/04/02/price-return-vs-total-return/">price return</a> of -6.3%, even before you take inflation into account. </p>
<p>This was at least a better performance than one major index, the Euro Stoxx 50. The constituents of this index are blue-chip companies from nine eurozone countries (Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands and Spain). Investing in this index in the same period would have reduced your pot by 33.6% (that’s £664 for your £1,000 investment after 20 years). </p>
<p>But both the FTSE 100 and Euro Stoxx 50 compare poorly against other international indices, as can be seen in the graph below (click on it to make it bigger). Over the same period, Japan’s Nikkei 300 went up 17.9%, Germany’s DAX achieved 81.2%, and the American Dow Jones Industrial Average achieved 142.7%. </p>
<p><strong>Stock indices compared</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/356314/original/file-20200903-16-fjdutp.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph of different stock market indices" src="https://images.theconversation.com/files/356314/original/file-20200903-16-fjdutp.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/356314/original/file-20200903-16-fjdutp.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=317&fit=crop&dpr=1 600w, https://images.theconversation.com/files/356314/original/file-20200903-16-fjdutp.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=317&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/356314/original/file-20200903-16-fjdutp.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=317&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/356314/original/file-20200903-16-fjdutp.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=398&fit=crop&dpr=1 754w, https://images.theconversation.com/files/356314/original/file-20200903-16-fjdutp.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=398&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/356314/original/file-20200903-16-fjdutp.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=398&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://uk.tradingview.com/chart/?symbol=TVC%3AUKX">Trading View</a></span>
</figcaption>
</figure>
<h2>Making sense of the numbers</h2>
<p>To some extent, the FTSE’s poor performance can be explained by external forces. If we only look at the period from January 31 2001 to May 31 2016, the month before the European referendum, the FTSE 100 was only down 1.1% (instead of our 20-year -6.3%). This was relatively better compared to the Euro Stoxx 50, which achieved -35.9% over that period. And although the pre-referendum FTSE 100 was still much worse than the Nikkei, DAX and Dow Jones, it is less so than before: their respective rises over the same period are 5.2%, 51% and 63.3%. </p>
<p>Even then, there have been several mitigating factors for the FTSE 100 since the Brexit vote. It reached an all-time peak in May 2018, buoyed by a weaker pound and <a href="https://www.theguardian.com/business/live/2018/may/21/markets-ftse-100-record-us-china-trade-war-truce-business-live">a truce</a> in the trade war between the US and China. </p>
<p>It has also performed particularly poorly since the COVID-19 outbreak. From January 2001 to January 2020, the FTSE 100 was actually up 15.7%. The Euro Stoxx 50 was down 23.8% over the same period, while the Nikkei, DAX and Dow Jones achieved 30.6%, 91.1% and 159.5% respectively. </p>
<p>This means that Brexit and COVID-19 might explain some of the poor performance of FTSE 100 companies in the last two decades. But what other factors are in play?</p>
<p>The companies in the FTSE 100, especially the biggest ones, tend to belong to traditional industries such as pharmaceuticals (AstraZeneca and GlaxoSmithKline), banking (HSBC), mining (BHP), and oil and gas (Royal Dutch Shell and BP). The exposure of the index to the banking industry has perhaps been particularly detrimental to the performance of the FTSE 100. </p>
<p>The graph below plots the performance of the whole index against the performance of its banking and computing stocks. As you can see, banking stocks have performed particularly badly in the last two decades. For example Barclays’s stocks have lost around 48% of their value since 2001. One of the reasons for such a poor performance, in addition to the financial crisis, is <a href="https://www.cityam.com/the-ftse-100-is-lagging-behind-soaring-global-markets-but-why/">likely to be</a> that low interest rates have squeezed <a href="https://www.sciencedirect.com/science/article/pii/S1042957317300372?casa_token=rX5n1_Z2Q1AAAAAA:V5lVZbdhUMEO5QImyjzw02F_FN6n8aPFo3u9H8u9eHE95ZtR26Bsn98bZN2W3t34MwnjRmeM">banks’ profit margins</a>.</p>
<p><strong>Total FTSE 100 vs banking and computing stocks</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/356357/original/file-20200903-20-1ghwuyk.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph of FTSE share performance 2001-20" src="https://images.theconversation.com/files/356357/original/file-20200903-20-1ghwuyk.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/356357/original/file-20200903-20-1ghwuyk.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=316&fit=crop&dpr=1 600w, https://images.theconversation.com/files/356357/original/file-20200903-20-1ghwuyk.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=316&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/356357/original/file-20200903-20-1ghwuyk.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=316&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/356357/original/file-20200903-20-1ghwuyk.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=397&fit=crop&dpr=1 754w, https://images.theconversation.com/files/356357/original/file-20200903-20-1ghwuyk.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=397&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/356357/original/file-20200903-20-1ghwuyk.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=397&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
</figcaption>
</figure>
<p>Another potential reason for the underperformance of the FTSE 100 is that there are very few IT companies. Tech stocks like Apple and Microsoft have a very large weighting in the US, but their UK-listed equivalents <a href="https://siblisresearch.com/data/ftse-100-sector-weights/">represent a</a> very small weight in the FTSE 100. </p>
<p>The reason why the share prices of IT companies tend to perform better is that they are usually younger and thus have stronger growth opportunities. True to form, the IT companies on the FTSE 100 have performed relatively well in the past decade, even if they have been quite volatile in the last couple of years, <a href="https://www.forbes.com/sites/kasiaborowska/2019/03/22/the-uk-tech-industry-needs-brexit-clarity-now/">probably because of</a> the uncertainty related to the threat of a no-deal Brexit. </p>
<p>For example, <a href="https://www.avast.com/en-gb/index#mac">Avast</a> is a Czech company that has been listed in London since May 2018. Since then, the stock price <a href="https://www.hl.co.uk/shares/shares-search-results/a/avast-plc-ord-gbp0.10">has grown</a> by around 130%. </p>
<p>But it’s not only very young IT companies that have strong growth opportunities. <a href="https://www.aveva.com/">Aveva</a> is another FTSE 100 company listed in London, having been founded in 1967 in Cambridge as a government-funded research institute. Its annual average growth in stock price has been 182% since 2001. </p>
<h2>Small caps and dividends</h2>
<p>But if these factors have all played a role in why the FTSE 100 has compared poorly in price terms, there are several other important caveats that rather change the picture. First, the weakness has mainly been with the large blue-chip companies listed in the UK. </p>
<p>You can see this when you look at the FTSE 250, which is an index of smaller companies that tend to be based the UK rather than having the international dimension of the FTSE 100. Over the same 20-year period, the FTSE 250 is up 51.4% – well ahead of the Nikkei and not far behind the DAX. </p>
<p>Second, we have so far only looked at the raw price return of the FTSE 100. This ignores the fact that traditional companies of the kind that dominate the FTSE 100 also distribute dividends. To get a full view of companies’ performance, you have to factor these in too. </p>
<p>According to the <a href="https://www.cazenovecapital.com/uk/financial-adviser/insights/strategy-and-economics/how-the-ftse-100-returned-94-without-moving/">calculations here</a>, the same £1,000 invested into the FTSE 100 that we talked about at the beginning of the article would have approximately doubled over the last couple of decades if you included the income from dividends and continually reinvested it back into companies in the index. Below is a chart to show the comparison over just the last five years. </p>
<p><strong>FTSE 100 Total Return vs FTSE 100</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/356533/original/file-20200904-24-179trgq.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Graph showing FTSE 100 Total Return vs shares only" src="https://images.theconversation.com/files/356533/original/file-20200904-24-179trgq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/356533/original/file-20200904-24-179trgq.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=300&fit=crop&dpr=1 600w, https://images.theconversation.com/files/356533/original/file-20200904-24-179trgq.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=300&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/356533/original/file-20200904-24-179trgq.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=300&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/356533/original/file-20200904-24-179trgq.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=377&fit=crop&dpr=1 754w, https://images.theconversation.com/files/356533/original/file-20200904-24-179trgq.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=377&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/356533/original/file-20200904-24-179trgq.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=377&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
</figcaption>
</figure>
<p>Though you would have to obtain the same data for our other indices to make a truly fair comparison, and I couldn’t source it all at the time of writing, the German DAX actually does include dividends in its numbers. So since it achieved 81.2% in our 20-year period, the UK returns turn out to be fairly similar.</p><img src="https://counter.theconversation.com/content/145516/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>In the past, Enrico Onali received funding from the Deutsche Bundesbank and Erasmus+. </span></em></p>Apple is now worth more than the entire FTSE 100. It says as much about the UK’s premier stock index as it does about American tech.Enrico Onali, Professor of Finance, University of ExeterLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1333742020-03-10T15:24:33Z2020-03-10T15:24:33ZCoronavirus market chaos: if central bankers fail to shore up confidence, then what?<figure><img src="https://images.theconversation.com/files/319656/original/file-20200310-61148-eu70q.jpg?ixlib=rb-1.1.0&rect=33%2C229%2C4474%2C2663&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">EPA/Justin Lane</span></span></figcaption></figure><p>Until recently, investors were enjoying substantial gains from a strong bull market in securities that essentially began in the depths of the financial crisis of 2007-09. With world markets now <a href="https://www.bbc.com/news/business/market-data">in serious turmoil</a>, COVID-19 has probably brought this trend to an end. This atypical leftfield event has put its vicelike grip around the windpipes of stock market bourses and commodity markets across the world, and shows no signs of letting go. </p>
<p>Market confidence is weak and asset prices are very unstable – with rebounds and fresh lows almost on consecutive days at the moment. Many stock markets are down by around 20% from January peaks, while oil has been destabilised by the price war between the Saudis and Russians. </p>
<p><strong>Dow Jones Industrial Average</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/319562/original/file-20200310-61076-17l3nnt.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/319562/original/file-20200310-61076-17l3nnt.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/319562/original/file-20200310-61076-17l3nnt.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=318&fit=crop&dpr=1 600w, https://images.theconversation.com/files/319562/original/file-20200310-61076-17l3nnt.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=318&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/319562/original/file-20200310-61076-17l3nnt.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=318&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/319562/original/file-20200310-61076-17l3nnt.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=399&fit=crop&dpr=1 754w, https://images.theconversation.com/files/319562/original/file-20200310-61076-17l3nnt.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=399&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/319562/original/file-20200310-61076-17l3nnt.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=399&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Google Finance</span></span>
</figcaption>
</figure>
<p><strong>WTI Crude Oil</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/319564/original/file-20200310-61120-13qmqzf.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/319564/original/file-20200310-61120-13qmqzf.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/319564/original/file-20200310-61120-13qmqzf.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=360&fit=crop&dpr=1 600w, https://images.theconversation.com/files/319564/original/file-20200310-61120-13qmqzf.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=360&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/319564/original/file-20200310-61120-13qmqzf.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=360&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/319564/original/file-20200310-61120-13qmqzf.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=453&fit=crop&dpr=1 754w, https://images.theconversation.com/files/319564/original/file-20200310-61120-13qmqzf.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=453&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/319564/original/file-20200310-61120-13qmqzf.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=453&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.macrotrends.net/2516/wti-crude-oil-prices-10-year-daily-chart">MacroTrends</a></span>
</figcaption>
</figure>
<p>As quarantine and isolation measures pick up momentum in various critical markets, there is an air of panic about what lies ahead. Perhaps more importantly, how are the Masters of the Universe, aka the central bankers, going to react to this situation and breathe life back into asset prices?</p>
<p>Central banks responded to the 2007-09 financial crisis by sharply reducing interest rates and unleashing <a href="https://theconversation.com/quantitative-easing-now-looks-permanent-and-has-turned-central-banks-into-pseudo-governments-130098">quantitative easing</a> (QE) – essentially creating trillions of dollars to buy government bonds and other assets to prop up markets. This enabled the banks to recover and create additional cheap credit to propel the economy forward from deep recession. </p>
<p>The line in the chart below shows the growth of all US debt over decades, which is a decent proxy for the world as a whole. You can see that growth soon resumed once the central bank policy response to the last economic crisis was in place. There is a <a href="https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1150.pdf">direct correlation</a> between the growth of firms, increasing GDP and ever-increasing debt creation via banks. In other words, when the debt tap switches off, the economy goes into a deep stall. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/319556/original/file-20200310-61084-1kydicm.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/319556/original/file-20200310-61084-1kydicm.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/319556/original/file-20200310-61084-1kydicm.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=422&fit=crop&dpr=1 600w, https://images.theconversation.com/files/319556/original/file-20200310-61084-1kydicm.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=422&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/319556/original/file-20200310-61084-1kydicm.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=422&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/319556/original/file-20200310-61084-1kydicm.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=530&fit=crop&dpr=1 754w, https://images.theconversation.com/files/319556/original/file-20200310-61084-1kydicm.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=530&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/319556/original/file-20200310-61084-1kydicm.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=530&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://fred.stlouisfed.org/">St Louis Federal Reserve</a></span>
</figcaption>
</figure>
<p>The 2007-09 central bank recovery strategy is problematic in two ways. In creating cheap debt, investors’ money and borrowings flow towards markets and asset classes that develop bubbles. Asset bubbles are a product of excessive demand and rising debt, where the prices of equities, bonds, property and so on exceed the underlying trading performance of the businesses <a href="https://theconversation.com/apples-share-price-has-doubled-but-there-is-a-crunch-coming-investors-should-watch-out-129997">to which they relate</a>. </p>
<p>Government and central-bank balance sheets have also still not recovered from all the monetary largesse post-2007 – indeed, QE has <a href="https://theconversation.com/quantitative-easing-now-looks-permanent-and-has-turned-central-banks-into-pseudo-governments-130098">broadly continued</a> to the present day. It is therefore questionable whether there is enough firepower to continue propping up a market that is in dire need of a correction that should have happened after the 2007 crisis. </p>
<h2>The new response</h2>
<p>To halt the declines in demand that are causing firms to collapse, particularly in sectors like <a href="https://theconversation.com/flybe-could-it-be-time-for-a-government-backed-regional-airline-133191">transport</a> and <a href="https://www.nbcnews.com/business/business-news/empty-sidewalks-deserted-hotels-coronavirus-slamming-tourism-industry-n1147061">tourism</a>, the US Federal Reserve <a href="https://www.nytimes.com/2020/03/03/business/economy/fed-rate-cut.html">made an</a> an emergency interest rate cut of 0.5 percentage points on Tuesday March 3. The Bank of England <a href="https://theconversation.com/budget-2020-new-uk-chancellor-unveils-30-billion-coronavirus-fightback-but-debt-forecasts-look-optimistic-133461">followed on</a> March 11, with additional support from HM Treasury when Chancellor Rishi Sunak unveiled his Budget. Predictions <a href="https://www.fxstreet.com/news/markets-now-see-73-probability-of-75-bps-fed-rate-cut-next-week-202003100057">are also rife</a> that there <a href="https://www.bloomberg.com/news/articles/2020-03-09/goldman-sachs-now-sees-fed-cutting-rate-back-to-record-low">will be</a> more emergency measures from the Fed soon. </p>
<p>From the market reaction to these interventions, there is little evidence of these moves working so far. And with interest rates already close to the <a href="https://theconversation.com/negative-interest-rates-will-not-fix-the-global-economy-just-ask-switzerland-130718">lowest level possible</a> – known as the zero-lower bound – there is limited room for manoeuvre. </p>
<p>The big issue is what happens if the virus persists into UK and US markets and default rates on the debt increase. Governments will potentially not only be dealing with a virus affecting public health but another contagion effect in financial debt markets in which investors start panicking about whether debts will be repaid and start demanding repayments.</p>
<p>Banks will take the hit. They are better prepared now to deal with credit losses because they have to hold more capital under the <a href="https://www.investopedia.com/articles/economics/10/understanding-basel-3-regulations.asp">Basel III banking regulations</a> and have invested heavily in so-called <a href="https://www.investopedia.com/terms/c/contingentconvertible.asp">Coco Bonds</a> that will help protect their balance sheets during a crisis by converting debts to shareholdings once certain thresholds have been breached. </p>
<p>But if containment measures fail – as we are seeing in Italy just now – the banks may still end up in trouble. They may also stop lending again, in which case the asset bubbles would collapse and a long-term recession would become a certainty. Central banks and governments would have to step in with more assistance: as well as further interest rate cuts, they look likely to try more QE and <a href="https://www.thebalance.com/what-was-the-bank-bailout-bill-3305675">potentially bailouts</a> like <a href="https://www.independent.co.uk/news/uk/politics/163850bn-official-cost-of-the-bank-bailout-1833830.html">in 2007-09</a> if necessary. But given the limited scope this time around, if the global economy stalls for the long term, these measures might still fail and central bankers could potentially lose control of the marketplace altogether. In such a situation, we would be in truly uncharted territory. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/319636/original/file-20200310-61076-iud3hi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/319636/original/file-20200310-61076-iud3hi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/319636/original/file-20200310-61076-iud3hi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/319636/original/file-20200310-61076-iud3hi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/319636/original/file-20200310-61076-iud3hi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/319636/original/file-20200310-61076-iud3hi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/319636/original/file-20200310-61076-iud3hi.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/319636/original/file-20200310-61076-iud3hi.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Shape of things to come.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/business-woman-curly-blonde-hair-wearing-1646005354">Fileopen Creation</a></span>
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</figure>
<p>Historically, virus or health-related scares <a href="https://www.marketwatch.com/story/heres-how-the-stock-market-has-performed-during-past-viral-outbreaks-as-chinas-coronavirus-spreads-2020-01-22">are typically</a> over within six to 12 months. Affected markets and associated asset prices see recovery within a year or so. But on this occasion, it may well be naive to be so optimistic. Financial markets have become dependent on a macroeconomic policy response from central banks that recirculates ever-increasing levels of debt while not allowing prices to ever correct themselves. As a result, today’s asset bubbles are far worse than in 2007. </p>
<p>If panic sets in, any correction is likely to be more serious than during the last financial crisis. The best hope is probably that news about the outbreak gets better and the economy somehow muddles through. To take a couple of steps away from the abyss would certainly be a welcome relief right now.</p><img src="https://counter.theconversation.com/content/133374/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ian Crowther does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The prospects of the Masters of the Universe fixing this problem look seriously in doubt.Ian Crowther, Senior Lecturer in Banking and Financial Markets, Sheffield Hallam UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1318692020-02-24T10:10:03Z2020-02-24T10:10:03ZThree financial firms could change the direction of the climate crisis – and few people have any idea<figure><img src="https://images.theconversation.com/files/315940/original/file-20200218-10976-1uu8yj7.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Dirty deeds done cheap. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-vector/oil-price-fall-illustration-red-down-243831277">Mangulina</a></span></figcaption></figure><p>A silent revolution is happening in investing. It is a paradigm shift that will have a profound impact on corporations, countries and pressing issues like climate change. Yet most people are not even aware of it.</p>
<p>In a traditional investment fund, the decisions about where to invest the capital of the investors are taken by fund managers. They decide whether to buy shares in firms like Saudi Aramco or Exxon. They decide whether to invest in environmentally harmful businesses like coal. </p>
<p>Yet there has been a steady shift away from these actively managed funds towards <a href="https://www.thebalance.com/actively-vs-passively-managed-funds-453773">passive or index funds</a>. Instead of depending on a fund manager, passive funds simply track indices – for example, an S&P 500 tracker fund would buy shares in every company in the S&P 500 in order to mirror its <a href="https://www.macrotrends.net/2324/sp-500-historical-chart-data">overall performance</a>. One of the great attractions of such funds is that their fees are dramatically lower than the alternative. </p>
<p>In 2019 there was a watershed in the history of finance. In the United States, the total value of actively managed funds <a href="https://www.bloomberg.com/news/articles/2019-09-11/passive-u-s-equity-funds-eclipse-active-in-epic-industry-shift">was surpassed</a> by passive funds. Globally, passive funds <a href="https://www.ft.com/content/a7e20d96-318c-11ea-9703-eea0cae3f0de">crossed</a> US$10 trillion (£7.7 trillion), a five-fold increase from US$2 trillion in 2007.</p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/OYpCxXuF3M8?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
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<p>This seemingly unstoppable ascent has two main consequences. First, corporate ownership has become concentrated in the hands of the <a href="https://www.cambridge.org/core/journals/business-and-politics/article/hidden-power-of-the-big-three-passive-index-funds-reconcentration-of-corporate-ownership-and-new-financial-risk/30AD689509AAD62F5B677E916C28C4B6">“big three” passive asset managers</a>: BlackRock, Vanguard and State Street. They are already the <a href="https://theconversation.com/these-three-firms-own-corporate-america-77072">largest owners of corporate America</a>. </p>
<p>The second consequence relates to the companies that provide the indices that these passive funds follow. When investors buy index funds, they effectively delegate their investment decisions to these providers. Three dominant providers have become increasingly powerful: MSCI, FTSE Russell and S&P Dow Jones Indices. </p>
<h2>Steering global capital flows</h2>
<p>With trillions of dollars migrating to passive funds, the role of index providers has been transformed. We traced this change in <a href="https://www.tandfonline.com/doi/full/10.1080/09692290.2019.1699147">a recent paper</a>: in the past, index providers only supplied information to financial markets. In our new age of passive investing, they are becoming market authorities. </p>
<p>Deciding who appears in the indices is not just something technical or objective. It involves some discretion by the providers and benefits some actors over others. By determining which players are included on the list, setting the criteria becomes <a href="https://press.princeton.edu/books/hardcover/9780691144795/the-new-global-rulers">an inherently political activity</a>. </p>
<p>Especially relevant are the dominant emerging markets stock indices, particularly the widely tracked <a href="https://www.msci.com/emerging-markets">MSCI Emerging Markets Index</a>. This is a list of large and medium-sized companies in 26 countries, including China, India and Mexico. </p>
<p>MSCI sets the standards for countries to qualify for inclusion. Above all, they have to guarantee free access to domestic stock markets for foreign investors. If a country is included, massive amounts of capital will flow into their national stock market almost automatically. As a result, MSCI and the other big three providers’ rival indices are now effectively steering global investment flows. </p>
<p>For example, when Saudi Arabia was recently added to the list of qualifying countries for these indices, it <a href="https://www.reuters.com/article/us-saudi-funds-msci/saudi-regulator-expects-40-billion-foreign-fund-inflows-after-msci-idUSKBN1JH1VH">was predicted</a> to trigger inflows into the Saudi stock market of up to US$40 billion. And when Saudi Aramco, the largest global oil producer, went public last year, it was fast-tracked by the same three index providers into their emerging markets indices. Millions of investors around the world now unknowingly hold shares in this controversial corporation – either through owning emerging markets index funds or having pensions that hold such funds on their behalf. </p>
<p>When China was added to the key emerging market indices in 2018, reportedly after <a href="https://www.wsj.com/articles/how-china-pressured-msci-to-add-its-market-to-major-benchmark-11549195201">heavy lobbying</a> from Beijing, the capital steering effect was expected to be larger by an order of magnitude. It <a href="https://www.scmp.com/business/companies/article/2146084/us400-billion-expected-flow-chinese-stocks-after-msci-inclusion">was estimated</a> that the long-term inflows into Chinese stocks would be up to US$400 billion. </p>
<h2>The future role of index providers</h2>
<p>The three dominant index providers’ income mainly derives from the funds replicating their indices, since they have to pay royalties for the privilege. The providers are therefore currently enjoying a fee bonanza. For 2019, <a href="http://ir.msci.com/events/event-details/msci-fourth-quarter-2019-earnings-call">MSCI reported</a> record revenues and said the assets tracking its indices were at all-time highs. </p>
<p>Our research suggests that these providers’ brands are so well established that competitors will struggle to take away that business. This suggests that MSCI, FTSE Russell and S&P Dow Jones will increase their role as a new kind of de facto global regulators. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/315941/original/file-20200218-11005-ycfm6n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/315941/original/file-20200218-11005-ycfm6n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/315941/original/file-20200218-11005-ycfm6n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=462&fit=crop&dpr=1 600w, https://images.theconversation.com/files/315941/original/file-20200218-11005-ycfm6n.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=462&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/315941/original/file-20200218-11005-ycfm6n.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=462&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/315941/original/file-20200218-11005-ycfm6n.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=581&fit=crop&dpr=1 754w, https://images.theconversation.com/files/315941/original/file-20200218-11005-ycfm6n.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=581&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/315941/original/file-20200218-11005-ycfm6n.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=581&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Soaring & Passive.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-illustration/3d-render-closeup-computer-keyboard-sp-1114516781">Alexandra Gigowska</a></span>
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<p>Arguably the most important aspect of their private authority for the future of our planet pertains to how corporations tackle climate change. BlackRock <a href="https://theconversation.com/blackrock-is-the-canary-in-the-coalmine-its-decision-to-dump-coal-signals-whats-next-129972">recently made headlines</a> with plans to divest from firms that make more than 25% of their revenues from coal. Yet this only applies to BlackRock’s actively managed funds: most of its funds track indices from the major index providers, so <a href="https://www.washingtonpost.com/business/blackrocks-climate-activism-has-a-passive-problem/2020/01/14/80e233d6-36c5-11ea-a1ff-c48c1d59a4a1_story.html">they will keep</a> investing in coal until the providers remove such companies from their indices. </p>
<p>Similarly, BlackRock, Vanguard and State Street <a href="https://www.cnbc.com/2020/01/14/blackrock-is-overhauling-its-strategy-to-focus-on-climate-change.html">all recently announced</a> they will increase their range of so-called ESG funds, which profess to exclude the worst performing firms according to environmental, social and governance criteria. Again, these criteria are increasingly defined by the index providers, using <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3438533">proprietary methodologies</a>. As The Economist <a href="https://www.economist.com/finance-and-economics/2019/12/07/climate-change-has-made-esg-a-force-in-investing">has noted</a>, the providers often decide which companies to include based on whether they go about their business sustainably rather than what business they are actually in. </p>
<p>For instance, Saudi Aramco <a href="https://www.saudiaramco.com/en/news-media/news/2018/study-shows-record-low-carbon-intensity-of-saudi-crude-oil">produces</a> few emissions extracting oil from the ground. It’s a comparatively “sustainable” oil company, but it’s still an oil company. Most ESG indices include industry leaders in each sector and exclude worst performers - irrespective of the industry. Consequently, many ESG funds still heavily invest in the likes of airlines, oil and mining companies. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/315936/original/file-20200218-10995-75hcmb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/315936/original/file-20200218-10995-75hcmb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/315936/original/file-20200218-10995-75hcmb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/315936/original/file-20200218-10995-75hcmb.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/315936/original/file-20200218-10995-75hcmb.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/315936/original/file-20200218-10995-75hcmb.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/315936/original/file-20200218-10995-75hcmb.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/315936/original/file-20200218-10995-75hcmb.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Best in the sector?</span>
<span class="attribution"><a class="source" href="https://pixabay.com/photos/power-station-energy-electricity-374097/">Steve Buissinne/Pixabay</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span>
</figcaption>
</figure>
<p>They are also sometimes quite arbitrary about who qualifies as a good performer. For instance, the American bank Wells Fargo <a href="https://www.researchaffiliates.com/en_us/publications/articles/what-a-difference-an-esg-ratings-provider-makes.html">is ranked</a> in the top third by one index provider, while another ranks it in the bottom 5%. </p>
<p>In short, this tightly interlinked group of three giant passive fund managers and three major index providers will largely determine how corporations tackle climate change. The world is paying little attention to the judgements they make, and yet these judgements look highly questionable. If the world is truly to get to grips with the global climate crisis, this constellation needs to be far more closely scrutinised by regulators, researchers and the general public. </p>
<hr>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/263883/original/file-20190314-28475-1mzxjur.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/263883/original/file-20190314-28475-1mzxjur.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=140&fit=crop&dpr=1 600w, https://images.theconversation.com/files/263883/original/file-20190314-28475-1mzxjur.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=140&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/263883/original/file-20190314-28475-1mzxjur.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=140&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/263883/original/file-20190314-28475-1mzxjur.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=176&fit=crop&dpr=1 754w, https://images.theconversation.com/files/263883/original/file-20190314-28475-1mzxjur.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=176&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/263883/original/file-20190314-28475-1mzxjur.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=176&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p><em><a href="https://theconversation.com/imagine-newsletter-researchers-think-of-a-world-with-climate-action-113443?utm_source=TCUK&utm_medium=linkback&utm_campaign=TCUKengagement&utm_content=Imagineheader1131869">Click here to subscribe to our climate action newsletter. Climate change is inevitable. Our response to it isn’t.</a></em></p><img src="https://counter.theconversation.com/content/131869/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jan Fichtner receives funding from the European Research Council (ERC) under the European Union’s Horizon 2020 research and innovation programme (grant no. 638946).</span></em></p><p class="fine-print"><em><span>Eelke Heemskerk receives funding from the European Research Council (ERC) under the European Union’s Horizon 2020 research and innovation programme (grant no. 638946).</span></em></p><p class="fine-print"><em><span>Johannes Petry receives funding from the Economic and Social Research Council. </span></em></p>Now that passive funds have eclipsed their actively managed competitors, climate finance is increasingly in some new pairs of hands.Jan Fichtner, Postdoctoral Researcher in Political Science, University of AmsterdamEelke Heemskerk, Associate Professor Political Science, University of AmsterdamJohannes Petry, ESRC Doctoral Research Fellow in International Political Economy, University of WarwickLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/665372016-10-05T15:41:51Z2016-10-05T15:41:51ZUK stock market shrugs off turbulent times as FTSE nears record high<figure><img src="https://images.theconversation.com/files/140488/original/image-20161005-14208-1ax3ytk.jpg?ixlib=rb-1.1.0&rect=0%2C0%2C1000%2C661&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/pic-144027550/stock-photo-stock-market-graph-on-a-tablet-computer.html?src=qxP-PemYkO8cE6USIAKLdA-1-69">SGM/Shutterstock</a></span></figcaption></figure><p>The UK’s index of leading companies, the FTSE 100, has <a href="http://www.bbc.co.uk/news/business-37549685">broken the 7,000 points barrier</a> and is approaching all-time highs at what might look like a deeply fragile moment. Markets are placing higher and higher values on British firms, despite a protracted period of uncertainty after the Brexit vote, while economies worldwide face tough conditions with little help left from central banks. So why is it suddenly boom time for traders in London’s square mile? </p>
<p>At first glance, this may be look like a case of “animal spirits” – those erratic bursts of market behaviour identified by the economist <a href="http://www.pkarchive.org/economy/GeneralTheoryKeynesIntro.html">John Maynard Keynes in his 1936 book</a>. Perhaps more tellingly though, the phenomenon has run in tandem with a continuous downward trend of the exchange rate of the pound to the dollar. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/140479/original/image-20161005-14227-8ontme.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/140479/original/image-20161005-14227-8ontme.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/140479/original/image-20161005-14227-8ontme.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=446&fit=crop&dpr=1 600w, https://images.theconversation.com/files/140479/original/image-20161005-14227-8ontme.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=446&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/140479/original/image-20161005-14227-8ontme.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=446&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/140479/original/image-20161005-14227-8ontme.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=560&fit=crop&dpr=1 754w, https://images.theconversation.com/files/140479/original/image-20161005-14227-8ontme.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=560&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/140479/original/image-20161005-14227-8ontme.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=560&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">How many dollars to you get to the pound?</span>
<span class="attribution"><a class="source" href="http://www.xe.com/currencycharts/?from=GBP&to=USD&view=2Y">www.xe.com</a></span>
</figcaption>
</figure>
<p>This simple fact means that the seemingly odd behaviour of UK investors may not be so far-fetched. The declining value of the pound means that exports are cheaper than imports. In effect, the market strength is not so much an assessment of the UK economy as it is a bet on how well UK multinationals will do selling goods in foreign markets.</p>
<p>This call by investors kicked in after the Brexit vote on June 23 in response to an immediate drop in the value of the pound. Of course, currency fluctuations don’t dictate everything and underlying the confidence of investors is a belief that things will only get so bad. </p>
<h2>Calming Carney</h2>
<p>Before the Brexit vote, Bank of England governor Mark Carney gave a <a href="http://www.bbc.co.uk/news/business-35751919">grim forecast</a> on the uncertainty surrounding the UK’s economy post Brexit, and accurately predicted the drop in the value of the pound.</p>
<p>His sombre but reassuring approach did enough. Investors were given two prompts: a weak currency, but a firm hand on the tiller. This seems to have spurred their optimism that Carney would be able to set the appropriate monetary policy targets whatever the EU exit strategy and would be able to overcome any economic shocks as Britain prepares to secede from the European Union. It doesn’t mean they are right, of course, but sentiment is (almost) everything in markets.</p>
<p>The Bank of England’s role doesn’t end there. Since the Brexit vote, it has acted to drive down the cost of borrowing and increase spending and investment in the real economy. The UK three-month generic yield on Treasury bills has been going down. These are low-risk, short-term borrowing instruments so the drop should encourage short-term borrowers to invest in them. </p>
<p>From an investor’s point of view, low interest rates provide a low cost of borrowing. When companies take advantage of such a low rate, they can borrowing cheaply and use the borrowed capital to expand. </p>
<p>For households, the Bank of England’s strategy <a href="http://www.bankofengland.co.uk/boeapps/iadb/Repo.asp?Travel=NIxIRxRSx">acts as a disincentive</a> to put their money into savings and current accounts and should in theory encourage investments elsewhere. In other words, the only rational response for equity investors to the central bank’s initiatives is to “buy, buy, buy”. </p>
<h2>Bringing home the Bacon</h2>
<p>If there is a long-term prospect, it is this. The ten-year nominal yield for generic government bonds has been edging upwards. This is an indication that while short-term yield has decreased, encouraging investors to borrow and invest now, in the long-run, the rise in the long-term yields signify that, on average, short-term yields will go up in the future (thus the costs of borrowing). The message is: if you want to borrow and invest, do it now rather than later. </p>
<p>This likely reflects Carney’s optimism about the future of the UK’s economy in the long-run. Just like everyone else, markets don’t have enough information yet to know for sure, but the noises from the central bank and from the government are enough to underpin some measure of confidence for now. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/140486/original/image-20161005-14212-10k5qnq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/140486/original/image-20161005-14212-10k5qnq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/140486/original/image-20161005-14212-10k5qnq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/140486/original/image-20161005-14212-10k5qnq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/140486/original/image-20161005-14212-10k5qnq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/140486/original/image-20161005-14212-10k5qnq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/140486/original/image-20161005-14212-10k5qnq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/140486/original/image-20161005-14212-10k5qnq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">For Queen and country.</span>
<span class="attribution"><a class="source" href="https://www.flickr.com/photos/59937401@N07/5474777324/in/photolist-9kMEyu-9LBtLk-3fgdwc-5Qpydi-7YHViU-d8XNJs-9NEYMC-9kP8co-9VDxpf-cBoVKd-9DSPrY-9DQ55F-9DSSfw-9NFk5w-9u4Ya4-9VC64W-b7oeNB-s1PDHa-8rpXCV-9kJFGX-dhug9N-in65Vo-3DTNUE-9VAmAB-a32o4Q-9Vy4xV-fwNBEY-dotR4Y-9EbvWM-6zQRUE-ibspRz-iT5t9q-6XwQj2-8PY4BV-cAEs9-pLf68i-4ixHor-e5d9M4-w3rTY-4HNeB7-8HcT89-PyrDr-qF3QNi-duGC8h-ds1B6b-98E2Eh-4Xt47T-4TwUQu-aRRcyD-eaSdUS">Images Money</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
</figcaption>
</figure>
<p>As any UK historian will attest, Brexit is not a unique event in terms of its effect. Britain experienced a very similar episode in 1992-93 <a href="http://www.telegraph.co.uk/finance/2773265/Billionaire-who-broke-the-Bank-of-England.html">after the official German reunification</a> a couple of years earlier, when the pound slumped from more than US$2 to US$1.42. The FTSE, on the other hand, showed a similar response to today, moving from 1,990 points in 1990 to 3,689 in 1995.</p>
<p>So, is it erratic animal psychology or well-versed investor rationality? Probably a bit of both. If history is any indication, it is the case that when subjected to economic uncertainty and adversity, the British people and its central bank will tend to work together to achieve economic prosperity. As Francis Bacon once said, “<em>scientia potestas est</em>” – knowledge is power. It is perhaps better translated as: “he who possesses (new and logical) information possesses the power to act on it”. We may not have much information right now, and little of it certain, but investors will act on what they can get.</p><img src="https://counter.theconversation.com/content/66537/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Handy Tan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The UK’s leading index of companies has broken the 7,000 points barrier despite fragile growth and the uncertainty of Brexit.Handy Tan, Senior Lecturer in Banking and Finance, Anglia Ruskin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/639812016-08-18T10:32:40Z2016-08-18T10:32:40ZWhat the stock market tells us about the British economy post-Brexit<figure><img src="https://images.theconversation.com/files/134621/original/image-20160818-12312-1ge5xay.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">shutterstock</span> </figcaption></figure><p>Britain’s economy after the vote to leave the European Union has been marked by one word: uncertainty. But the FTSE 100, the UK’s main stock index, seems to be ticking along nicely. Having quickly rebounded after the initial shock of Brexit caused a 3.15% drop, it rose a further 1.6% when the Bank of England cut the interest rate <a href="https://www.theguardian.com/business/live/2016/aug/04/bank-of-england-interest-rates-stimulus-inflation-report-business-live">to a historic low of 0.25%</a> to counterbalance the <a href="http://www.bankofengland.co.uk/publications/Pages/news/2016/008.aspx">potential negative effects</a> of Brexit on the UK economy. </p>
<p>A stock market rise was the expected result of the announcement and research has shown how interdependent <a href="http://www.sciencedirect.com/science/article/pii/S0304393208001748">interest rate moves and stock prices are</a>. Lower interest rates generally lead to an increase in share prices because they make bonds less attractive and decrease the cost of borrowing for new investments. </p>
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<p>The FTSE will also have been buoyed by the drop in the pound, which decreases costs for multinational UK companies. Plus, the Bank of England’s <a href="https://www.theguardian.com/business/2016/aug/04/bank-of-england-cuts-uk-interest-rates">pledge to implement more quantitative easing</a> involves buying corporate bonds to help reduce the cost of capital of UK corporations and increase profits. </p>
<p>But this data refers to the short-term reaction of the stock market. The long-term consequences strongly depend on whether it is believed that the interest rate cut will improve the economic outlook of the UK. This does not look promising.</p>
<h2>A few problems ahead</h2>
<p>Banks can be reluctant to lend in periods of uncertainty, as economists Atif Mian and Amir Sufi point out in their book <a href="http://houseofdebt.org/">House of Debt</a>. This could limit the extent to which banks pass the benefits of the interest rate cut onto consumers. Also, households themselves may not want to borrow more because of the uncertainty brought on by Brexit. An interest rate cut of a mere 0.25% may not be enough to convince banks to lend more and households to borrow more.</p>
<p>Another problem to consider is that although interest rates have hit record lows, they were already very low, <a href="http://www.bankofengland.co.uk/boeapps/iadb/Repo.asp">at 0.5% since March 2009</a>. This means that there is now little room for monetary policy to influence economic activity further. This condition, commonly known as the “zero lower bound”, suggests that a further interest rate cut, <a href="http://www.ft.com/cms/s/0/84d51d28-5ed8-11e6-a72a-bd4bf1198c63.html">which has been hinted at</a>, may fall short of improving the economic outlook. The fact that the Bank of England’s governor, Mark Carney, is <a href="https://www.theguardian.com/business/2016/feb/23/bank-of-england-could-cut-interest-rates-to-zero-but-not-below-says-mark-carney">reluctant to push interest rates below zero</a> reflects the fact that monetary policy has very limited power left to stimulate the economy.</p>
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<p>The impact of quantitative easing (QE) programme could also turn out to be moot, as it may simply inflate asset prices without stimulating consumption. The QE effect usually affects high net worth individuals, who represent a relatively small proportion of UK households and whose propensity to consume is not affected by uncertainty as much as those who are less well-off. This happens because the proportion of income that poorer households spend on essential items (food, clothing, accommodation) is much higher than for wealthy households. </p>
<h2>Good news hiding the bad?</h2>
<p>If and when more of the same economic medicine fails to work, it may be necessary to use <a href="https://theconversation.com/helicopter-money-why-economists-are-now-thinking-the-unthinkable-57774">“helicopter money”</a>. Rather than lowering interest rates, the government could bypass banks and directly inject cash into the economy, thereby increasing the likelihood that it would be used to improve consumption and aggregate demand – exactly what is needed in the UK right now. </p>
<p>Of course, this does not mean that we should expect helicopters to drop banknotes over crowds in Trafalgar Square. But the government could, among other alternatives, increase salaries for government employees, or decide to invest in key <a href="https://www.theguardian.com/business/2016/aug/03/cash-handouts-are-best-way-to-boost-growth-say-economists">infrastructure projects</a>. At the moment, despite the support of some economists, it is unclear whether the government is willing to undertake such an innovative strategy.</p>
<p>In my view, however, it is the reluctance of the UK government to trigger <a href="https://theconversation.com/what-is-article-50-the-law-that-governs-exiting-the-eu-and-how-does-it-work-60262">Article 50</a>, which officially begins Brexit proceedings, that should be of major concern. In recent <a href="http://www.sciencedirect.com/science/article/pii/S016517651630266X">research</a>, I found just how reluctant people in charge are to release bad news. An investigation of dividend announcements in more than 1,500 US companies between 1971 to 2014 suggested that the majority of firms would announce increases in the dividend per share (good news) early, while announcements of dividend cuts (bad news) tended to be delayed. </p>
<p>The suggestion that the government <a href="http://www.independent.co.uk/news/uk/politics/brexit-date-article-50-eu-referendum-result-europe-theresa-may-a7189851.html">may wait until 2019</a> before triggering Article 50 indicates that it is trying to buy as much time as possible before delivering some very bad news to the British public when it comes to the economy’s performance. The delay suggests it is unlikely that the government believes the interest rate cut will be enough to offset the potential negative impact of Brexit.</p><img src="https://counter.theconversation.com/content/63981/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Enrico Onali has received funding from the Deutsche Bundesbank for a research project on "Bank distress and household portfolio choice". He is a Fellow of the Higher Education Academy.</span></em></p>The FTSE rebounded after its Brexit shock – but how long will it last?Enrico Onali, Senior Lecturer in Finance, Aston UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/616902016-06-27T16:32:38Z2016-06-27T16:32:38ZDon’t believe the Brexit prophecies of economic doom<figure><img src="https://images.theconversation.com/files/128361/original/image-20160627-28395-1kt9fxg.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Looking behind the headline numbers.</span> <span class="attribution"><span class="source">shutterstock.com</span></span></figcaption></figure><p>The shock and horror at the Brexit vote has been loud and vociferous. Some seem to be revelling in the uncertainty that the referendum result has provoked. The pound falling in value, a downturn in markets – it lends credence to the establishment’s claims before the referendum that a Leave vote would lead to economic Armageddon.</p>
<p>But there are plenty of reasons to reject the consensus that Brexit will be costly to the UK’s economy. Even though markets appear stormy in the immediate aftermath of the vote, the financial market reaction to date has more characteristics of a seasonal storm than of a major catastrophe.</p>
<p>We were told that the consensus of economic experts were overwhelmingly opposed to a Brexit. Lauded institutions – from the IMF, OECD to the Treasury and London School of Economics – produced <a href="https://theconversation.com/which-brexit-forecast-should-you-trust-the-most-an-economist-explains-59992">damning forecasts</a> that ranged from economic hardship to total disaster if the UK leaves the EU. Yet 52% percent of the British electorate clearly rejected their warnings.</p>
<p>Something that my professional experience has taught me is that when an “accepted consensus” is presented as overwhelming, it is a good time to consider the opposite. Prime examples of this are the millennium bug, the internet stock frenzy, the housing bubble, Britain exiting the European exchange rate mechanism (ERM) and Britain not joining the euro. In each of these examples, the overwhelming establishment consensus of the time turned out to be wrong. I believe Brexit is a similar situation.</p>
<h2>Downright dangerous</h2>
<p>The economic models used to predict the harsh consequences of a Brexit are the tools of my profession’s trade. Used properly, they help us to better understand how systems work. In the wrong hands they are also downright dangerous. The collapse of the hedge fund <a href="http://www.businessinsider.com/the-fall-of-long-term-capital-management-2014-7?IR=T">Long-Term Capital Management in 1998</a> and the <a href="http://www.economist.com/news/schoolsbrief/21584534-effects-financial-crisis-are-still-being-felt-five-years-article">mispricing of mortgage backed securities</a> leading up to the 2008 financial crisis are just two of many examples of harmful consequences arising from the abuse of such models. </p>
<p>The output of these often highly sophisticated models depends entirely upon the competence and integrity of the user. With miniscule adjustment, they can be tweaked to support or contradict more or less any argument that you want.</p>
<p>The barrage of dire economic forecasts that were delivered before the referendum were flawed for two main reasons. First, they failed to acknowledge the risks of remaining in the EU. And second, the independence of the forecasters is open to question. </p>
<p>Let’s start with the supposed independence of the forecasting institutions. While economists should in theory strive to be independent and objective, Luigi Zingales from the University of Chicago provides a <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2353489">compelling argument</a> that, in reality, economists are just as susceptible to the influence of the institutions paying for their services as in other industries <a href="https://www.washingtonpost.com/news/volokh-conspiracy/wp/2014/05/18/regulatory-and-academic-capture/">such as financial regulators</a>. </p>
<h2>Peer pressure</h2>
<p>Another challenge faced by economists is presented by the nature of the subject matter. Economics is a social science which, at its heart, is about the psychology of human social interactions. Many models try to resolve the difficulties that human subjectivity causes by imposing assumptions of formal rationality on their models. But what is and is not rational is subjective. In further recognition of this difficulty the sub-discipline of behavioural economics <a href="http://economicspsychologypolicy.blogspot.co.uk/">has evolved</a>. </p>
<p><a href="https://www.imf.org/external/pubs/ft/wp/2000/wp0048.pdf">Herding</a> is a concept that has been used to rationalise financial market bubbles and various other behaviour. It describes situations in which it seems rational for individuals to follow the perceived consensus. Anyone who has found themselves in a position where the majority of their company has a radically different view to their own will have experienced the difficulty of standing out from the crowd. </p>
<p>In 2005-06, <a href="https://global.oup.com/academic/product/house-prices-and-the-macroeconomy-9780199204595?cc=gb&lang=en&">various</a> <a href="http://www.econ.yale.edu/%7Eshiller/pubs/p1089.pdf">people</a> (including <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=963993">myself</a>) presented the view that house prices would crash. While some audiences were sympathetic, the majority view at the time was both hostile and derisory. Challenging the received wisdom exposes you to feelings of isolation. </p>
<p>Received wisdom among academia has been that the EU is a force for good that should be defended at all costs. Respected colleagues are incredulous that anyone with their education and professional insights could think otherwise and remain part of the academic “in” crowd. In such an environment, it is very difficult to challenge this orthodoxy. </p>
<p>I – and the bulk of the UK population – might have been convinced by the pro-Remain economists if they had been a little more honest about the limitations of their models, and the risks of remaining inside the EU. </p>
<h2>Market reactions</h2>
<p>Despite reports of markets crashing following the Brexit result, when you put the current level of volatility in context of other shocks, market conditions are not as bad as they might seem. The FTSE 100 is still higher than it was barely two weeks ago and the more UK-focused FTSE 250 is currently higher than it was in late 2014. This is the kind of volatility that markets see two or three times a year.</p>
<p>The volatility index for the US S&P, known as the VIX or the “fear gauge”, is what is widely used to measure how uncertain global financial market participants are about the outlook for stocks. When the Brexit result was first announced, the VIX moved sharply, but has since settled in the mid-20s. To <a href="http://www.cboe.com/micro/charts/vix.aspx">put this in context</a>, the all-time average is 20.7, the all-time closing low is 8.5 and the all-time closing high on Black Monday in 1987 was 150. More recently during the financial crisis, it reached a closing high of 87.2 in November 2008. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/128355/original/image-20160627-28391-eh36vv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/128355/original/image-20160627-28391-eh36vv.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=274&fit=crop&dpr=1 600w, https://images.theconversation.com/files/128355/original/image-20160627-28391-eh36vv.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=274&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/128355/original/image-20160627-28391-eh36vv.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=274&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/128355/original/image-20160627-28391-eh36vv.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=344&fit=crop&dpr=1 754w, https://images.theconversation.com/files/128355/original/image-20160627-28391-eh36vv.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=344&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/128355/original/image-20160627-28391-eh36vv.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=344&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">VIX volatility chart.</span>
<span class="attribution"><a class="source" href="http://www.cboe.com/micro/charts/vix.aspx">CBOE</a></span>
</figcaption>
</figure>
<p>Other financial indicators also moved rapidly as the referendum results came through. On the face of it, the Japanese market suffered a severe shock falling almost 8%. However, the 8% fall in the Japanese stock market is almost exactly matched by an 8% gain of the Japanese yen relative to the pound. Therefore, the net effect for UK-based investors in Japanese equities is close to zero. </p>
<p>The fall in the value of the pound following the Brexit result is also not as bad as it may first appear. The size of the fall was exacerbated by the previous day’s assumption that Remain would win. There is also precedent for a dramatic fall – after the ERM crisis – which proved beneficial for many British exporting companies and arguably helped sustain the economic recovery of the 1990s.</p>
<p>A lower pound benefits companies that add most of the value to their products inside the UK, and companies that sell their produce on international markets. This includes exporters like pharmaceutical company GlaxoSmithKline, drinks company Diageo and technology company ARM – all of which saw stock price gains on the morning after the vote. Companies that rely on imports and add little value within the UK will be hardest hit in the short term as they adapt to the exchange rate volatility.</p>
<p>There will undoubtedly be winners and losers from the UK’s decision to leave the EU. But indexes for volatility are already lower than they were in February this year, suggesting that markets are not abnormally worried about the outlook, and UK government borrowing costs are at an all time low. This is further reason to reject the pre-referendum consensus that Brexit would bring economic doom.</p><img src="https://counter.theconversation.com/content/61690/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Isaac Tabner is a member of the CFA Institute, the CFA Society of the UK and the Personal Finance Society.</span></em></p>There are plenty of reasons to reject the consensus that Brexit will be costly to the UK economy.Isaac T. Tabner, Senior Lecturer in Finance, University of StirlingLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/615352016-06-24T13:37:02Z2016-06-24T13:37:02ZHow Brexit triggered a global market meltdown<p>Despite reassurances that we shouldn’t listen to the experts, the financial markets have gone and behaved almost exactly <a href="https://www.theguardian.com/commentisfree/2016/jun/20/brexit-crash-pound-living-standards-george-soros">as the experts predicted</a>. Following the news that the UK will be leaving the EU, the pound has dropped to a level <a href="http://www.bbc.co.uk/news/business-36611512">not seen since 1985</a>. The FSTE has had the biggest <a href="http://www.telegraph.co.uk/business/2016/06/23/markets-live-will-sterling-surge-or-slump-as-the-eu-referendum-c/">one day drop ever</a>. </p>
<p>On top of this, the yields of UK government bonds has hit an <a href="https://next.ft.com/content/0aac95da-39c1-11e6-9a05-82a9b15a8ee7">all time low</a>. The price of commodities such as oil <a href="http://www.cnbc.com/2016/06/23/brexit-jitters-keep-oil-gold-choppy.html">dropped 6% on the Brexit vote</a>. House builders have been particularly hard hit, suggesting massive declines in the property sector. Alternatives assets like gold and bitcoin <a href="http://www.theverge.com/2016/6/24/12023402/brexit-bitcoin-value-price-surge">have rallied</a> as people look for safe places to stash their money.</p>
<p>This very British crisis has quickly cascaded across national borders. The German share market <a href="http://www.dw.com/en/stock-markets-plummet-following-brexit/a-19351596">fell 10%</a> and the French market <a href="http://www.cnbc.com/2016/06/24/ftse-stocks-markets-fall-brexit-wins-eu-referendum-pound-euro-dollar-plummets-gold-spike-oil-price.html">fell 8%</a>. Outside of Europe there have been big falls on <a href="http://www.cnbc.com/2016/06/23/asia-stocks-to-focus-on-uk-brexit-referendum-results-weaker-yen-gains-in-us-stocks.html">Japanese and Australian share markets too</a>. Futures suggest that the American S&P 500 and the Nasdaq indexes <a href="http://money.cnn.com/2016/06/24/investing/premarket-stocks-trading/">will both open down 5%</a> as well.</p>
<p>So what started out as a vote by some angry people in England has rapidly become a global economic event. It has spread across continents and asset classes. It has unleashed a kind of contagion which was last seen during the financial crisis of 2008. </p>
<h2>Complex web</h2>
<p>This contagion happens as falls in one asset class start to make another look more vulnerable. For instance as shares in banks go down, other funds which hold shares in these banks are likely to look increasingly shaky. Given the complex web of interlocking assets in the global financial system, it is often difficult to say when the contagion might stop. It could mean that assets which are not fundamentally affected by Brexit take a price hit – at least in the short term. </p>
<p>Another common dynamic which kicks off when there are large scale and complex economic events such as Brexit is <a href="https://ore.exeter.ac.uk/repository/bitstream/handle/10871/15161/Information_and_ambiguity_herd_and_contrarian_behaviour_in_financial_markets.pdf?sequence=5&isAllowed=y">herd-like behaviour</a>. The surprise of the referendum outcome led to usual assumptions being thrown out the window. In these situations traders increasingly look to each other for a sense of what an asset is actually worth.</p>
<p>As a result, they can start to ignore the fundamentals and start to follow what the crowd is doing. Social proof is relied on by traders, rather than actual proof. In some cases this leads to the creation of asset bubbles. In other cases, like Brexit, it can create negative feedback loops which lead to massive falls in assets. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/128061/original/image-20160624-28349-14m9bpt.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/128061/original/image-20160624-28349-14m9bpt.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=388&fit=crop&dpr=1 600w, https://images.theconversation.com/files/128061/original/image-20160624-28349-14m9bpt.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=388&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/128061/original/image-20160624-28349-14m9bpt.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=388&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/128061/original/image-20160624-28349-14m9bpt.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=488&fit=crop&dpr=1 754w, https://images.theconversation.com/files/128061/original/image-20160624-28349-14m9bpt.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=488&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/128061/original/image-20160624-28349-14m9bpt.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=488&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Currency cliff.</span>
<span class="attribution"><a class="source" href="http://www.xe.com/currencycharts/?from=GBP&to=USD&view=1D">xe.com</a>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<p>As falls in markets around the world pick up steam, they could easily start to connect up with wider global economic issues which have been simmering away in the background. These include the slow burning <a href="http://foreignpolicy.com/2016/05/24/is-china-on-a-path-to-debt-ruin-chinafile-conversation-economic-reform/">debt crisis in China</a>, problems <a href="https://theconversation.com/why-brazils-economic-rollercoaster-is-far-from-over-57372">with the Brazilian economy</a> in recent months, or over-inflated housing markets in some parts of the world. And, given that most trading strategies today are automated, there could be some nasty and unpredictable surprises hiding deep within a company’s algorithms. </p>
<p>When economic news sours, investors tend to start being more vigilant. They look more closely at their portfolios and are more likely to dispose of assets which they are a bit concerned with. As a result they get rid of good assets in an attempt to put their mind at rest. This can then create falls in asset prices.</p>
<h2>Stopping the rout?</h2>
<p>Central banks usually have the ability to step in to calm things down – mainly by lowering interest rates to encourage additional economic activity. The problem is that with interest rates at close to zero, central bankers don’t have a lot of room for manoeuvre. This only leaves the option of quantitative easing – a solution that can simply kick the can down the road. It is uncertain whether slick communication from central bankers – as the Bank of England governor Mark Carney was swift to do on the heels of Brexit – is enough at moments like this. </p>
<p>Contagion, herding and misplaced vigilance are only likely to create more uncertainty about when financial markets will settle. It may be some time before we actually know how they will settle down after their Brexit shock. After all, we have no idea what Brexit will actually look like and it will <a href="https://theconversation.com/britain-votes-to-leave-the-eu-cameron-quits-heres-what-happens-next-61420">likely be two years before we do</a>. </p>
<p>In the meantime, HSBC predicts the pound will continue to fall to as low as US$1.20 <a href="http://www.bloomberg.com/news/articles/2016-06-24/hsbc-prepare-for-stagflation-in-the-u-k">by the end of the year</a>. And market volatility is likely to continue for some time as the news triggers off all sorts of contagion, via the complex networks that financial markets run on.</p><img src="https://counter.theconversation.com/content/61535/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andre Spicer does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A plummeting pound, bonds at an all time low, stocks and commodities in freefall. The UK just spooked the world.Andre Spicer, Professor of Organisational Behaviour, Cass Business School, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/382512015-03-02T18:18:14Z2015-03-02T18:18:14ZFTSE 100 to burst through 7,000? Not before election day<figure><img src="https://images.theconversation.com/files/73489/original/image-20150302-15984-1g1i55.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Where next for the FTSE 100?</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com/cat.mhtml?lang=en&language=en&ref_site=photo&search_source=search_form&version=llv1&anyorall=all&safesearch=1&use_local_boost=1&searchterm=stock%20market%20high&show_color_wheel=1&orient=&commercial_ok=&media_type=images&search_cat=&searchtermx=&photographer_name=&people_gender=&people_age=&people_ethnicity=&people_number=&color=&page=1&inline=193263167">Ismagilov</a></span></figcaption></figure><p>The FTSE 100 may have ticked <a href="http://www.bbc.co.uk/news/business/market_data/stockmarket/3/default.stm">down slightly</a> since hitting an all-time high of 6,949.24 on February 26, but it remains above the previous record peak of 6,930.2 set more than 15 years ago on December 30 1999. </p>
<p>Of course, for the result to be truly meaningful you have to adjust for 15 years of reinvested dividends, inflation, tax and transaction costs. Having accounted for these adjustments using data from Bloomberg and Thomson Reuters Datastream, I found that the total real return of the FTSE 100 over this period is only negligibly different from zero. Atypically, in other words, this is a case where the nominal and adjusted 15-year returns coincide.</p>
<p>The difference between the highs of December 1999 and February 2015 is that the former occurred just a few months before the peak of the dotcom bubble, <a href="http://press.princeton.edu/titles/10421.html">the greatest</a> stock market overvaluation of all time. </p>
<p><strong>FTSE 100 over 20 years</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/73492/original/image-20150302-15987-1qu5gcy.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/73492/original/image-20150302-15987-1qu5gcy.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/73492/original/image-20150302-15987-1qu5gcy.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=377&fit=crop&dpr=1 600w, https://images.theconversation.com/files/73492/original/image-20150302-15987-1qu5gcy.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=377&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/73492/original/image-20150302-15987-1qu5gcy.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=377&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/73492/original/image-20150302-15987-1qu5gcy.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=474&fit=crop&dpr=1 754w, https://images.theconversation.com/files/73492/original/image-20150302-15987-1qu5gcy.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=474&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/73492/original/image-20150302-15987-1qu5gcy.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=474&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.google.co.uk/finance?authuser=0&q=INDEXFTSE%3AUKX&ei=WIr0VLiuIuiKwgOBo4HoAQ">Google Finance</a></span>
</figcaption>
</figure>
<h2>Why the FTSE is no longer overvalued</h2>
<p>When stocks are grossly overvalued, a long period of poor stock-market returns is naturally what we would expect. The past 15 years’ performance is in line with what was predicted by the <a href="http://press.princeton.edu/titles/10421.html">historical record</a> of previous bubbles and the <a href="http://press.princeton.edu/titles/7239.html">valuation models</a> of behavioural finance, not to mention ordinary common sense. </p>
<p>After 15 years of corporate profit growth, albeit with the intervening global insolvency crisis of 2008, the FTSE is now on a respectable dividend yield of 3.6% and a price-to-earnings (P/E) ratio of 16 – compared to a 2% yield and a P/E ratio of 27 at the 1999 peak. When measured against historical averages, the index is now close to fair value. </p>
<p>So having broken one psychologically significant barrier and within sight of another, the 7,000 level, what are the prospects of the FTSE soaring over the coming months? Probably not very great.</p>
<h2>Odds and the general election</h2>
<p>The UK general election of May 7 is setting another record: the toughest to call <a href="http://www.theguardian.com/commentisfree/2015/feb/06/what-happens-nobody-wins-election-1974-warning">since 1974</a>. Pre-election odds <a href="http://nrl.iis.sinica.edu.tw/Web2.0/presentation/0807-present1.pdf">consistently outperform</a> the predictions of both professional political experts and surveys of voter intentions. This is true not only in the week immediately preceding the election, but also months in advance. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/73493/original/image-20150302-15965-1y94fii.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/73493/original/image-20150302-15965-1y94fii.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/73493/original/image-20150302-15965-1y94fii.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=900&fit=crop&dpr=1 600w, https://images.theconversation.com/files/73493/original/image-20150302-15965-1y94fii.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=900&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/73493/original/image-20150302-15965-1y94fii.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=900&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/73493/original/image-20150302-15965-1y94fii.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1131&fit=crop&dpr=1 754w, https://images.theconversation.com/files/73493/original/image-20150302-15965-1y94fii.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1131&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/73493/original/image-20150302-15965-1y94fii.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1131&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">Next UK election: anyone’s guess.</span>
<span class="attribution"><a class="source" href="http://www.shutterstock.com/cat.mhtml?lang=en&language=en&ref_site=photo&search_source=search_form&version=llv1&anyorall=all&safesearch=1&use_local_boost=1&search_tracking_id=cWBp9Ch1EoEPadOLJYO2cA&searchterm=political%20gamble&show_color_wheel=1&orient=&commercial_ok=&media_type=images&search_cat=&searchtermx=&photographer_name=&people_gender=&people_age=&people_ethnicity=&people_number=&color=&page=1&inline=227046727">Duncan Andison</a></span>
</figcaption>
</figure>
<p>The betting odds <a href="http://www.oddschecker.com/politics/british-politics">currently predict</a> a better performance for the Conservatives than either political pundits or surveys. They imply a probability of 16% for a Conservative majority, but only a 9% probability for a Labour majority. The predictions of political commentators and <a href="http://www.theguardian.com/politics/2015/feb/28/ed-miliband-on-course-absolute-majority-labour-party">surveys</a>, on the other hand, have tended to favour Labour.</p>
<p>The betting odds <a href="http://nrl.iis.sinica.edu.tw/Web2.0/presentation/0807-present1.pdf">are giving</a> a probability of more than 75% for no overall majority. Combine this with the much higher probability of a minority government, hung parliament or a variety of potentially unstable coalition arrangements and you can only conclude that the UK is facing more political uncertainty than in the run-up to any election in decades.</p>
<h2>The political threat</h2>
<p>The outcome has the potential to make a difference to the markets. Labour is perceived to be anti-business and particular sectors are under threat. Utility companies have reason to fear Ed Miliband’s promised <a href="http://action.labour.org.uk/page/s/energy-calculator">temporary freeze</a> on utility prices, while the banking sector faces the <a href="http://www.independent.co.uk/news/uk/politics/labour-would-break-up-high-street-banks-within-a-year-of-winning-power-ed-miliband-promises-9065205.html">possible break-up</a> of the too-big-to-fail banks. </p>
<p>On the other hand, the political risks for the stock market would not disappear on the election of a Conservative majority. David Cameron’s <a href="http://www.telegraph.co.uk/news/newstopics/eureferendum/11324069/David-Cameron-a-Conservative-government-could-hold-EU-referendum-before-2017.html">promise of</a> an in-out referendum on membership of the EU would lead to an extended period of great political uncertainty. Needless to say, the consequences for the stock market of the most likely outcome, no overall majority, are complex. </p>
<p>Markets hate uncertainty. Whether caused by political or economic factors, it is generally accompanied by increased volatility and falling stock prices. Many institutional investors <a href="http://www.ft.com/cms/s/0/1c7f97b6-bd0e-11e4-b523-00144feab7de.html">are already</a> lowering their exposure to the UK market and adopting a wait-and-see attitude towards future purchases of UK stocks. </p>
<p>Political uncertainty is not the only factor affecting stock prices, of course. The trends for the UK and US economies have been positive for some time, for example, and the recent move to quantitative easing by the European Central Bank is already pushing European stock prices higher. </p>
<p>There appears to be no particular reason why the UK market should crash. But given the exceptionally high degree of political uncertainty and the consequent cautious approach to the UK market being taken by institutional investors, the UK stock market is unlikely to fly in the near future either.</p><img src="https://counter.theconversation.com/content/38251/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Arief Daynes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The stock market looks a good bet, despite reaching an all-time high late last month. But until the UK election is out of the way, you might want to steer clear.Arief Daynes, Principal Lecturer of Economics and Finance, University of PortsmouthLicensed as Creative Commons – attribution, no derivatives.