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Recent market volatility not just reflects uncertainty but makes businesses uncertain as well – possibly affecting growth, according to Goldman Sachs
Realised volatility sharply increased during July-September 2011 for major indices comprising S&P 500, Dow Jones EURO STOXX 50, FTSE 100, Deutsche Aktien Xchange 30, Nikkei 225, Hang Seng Index and KOSPI 200, according to Goldman Sachs’ October 2011 research on “Global Themes and Risks”. The research report further states that the volatility of the S&P 500 index has been above the historical norm, and that the recent spike is linked to worries on US government policy and economic deceleration.
The implied volatility in equities is one of the best indicators for financial market views of how uncertain the future might be. This kind of spike in uncertainty and volatility not only reflects economic worries but it will have an impact on the growth picture as well.
Most investors feel that this uncertainty is in turn a drag on the economy itself, and one that may dampen activity going forward. When uncertainty is high it may make sense to delay spending decisions until things become clearer, hence buyers would enter a ‘wait-and-see’ mode in the meantime.
The recent spike in volatility has hurt US equity issuance. For 2010, equity issuance totalled $205 billion and the same for 2011 till date has totalled $156 billion. There has been a significant drop in issuance for recent months. Increased fears of a full-blown crisis in Europe and another recession in the United States have heightened global risk aversion, negatively affecting equities and currencies.
As the Goldman Sachs Global Economics Weekly—The Risks to Global Growth from Spiking Volatility mentions, “One of the most striking complaints from investors and businesses over the past few months has been that uncertainty about the future economic outlook is so much higher than normal, making it harder to commit to decisions to spend, hire or invest. Uncertainty about the euro-zone sovereign crisis, the US debt debate, the fiscal hangover from the crisis, the regulatory response and the efficacy of counter-cyclical policies are all frequently cited issues that cloud the outlook.”
So what has been the cause for the sharp rise in market volatility? As the Goldman Sachs report puts it, “The messiness of the US debt ceiling debate and the intensification of the euro-zone crisis over the summer were the proximate causes, but concerns about a renewed recession against the background of constrained policy have loomed large.”
The volatility shock is just two months old, thus much of the data needed to assess its impact may not yet be available. The uncertainty shock may not be over and it may not be the only shock. There have been recurrence of bouts of extreme market volatility; there was one in May 2010 and again this year. Issues that have generated uncertainty—the US fiscal debate and the constraints on monetary policy—are unlikely to fade soon either. The direct impact on financial conditions has been sizable in places, particularly in some European economies. And in the US, there is still worry about the impact of fiscal restraint. These forces may ultimately play a greater role in determining the outlook than the impact of higher uncertainty and volatility.
What will be the risk? “The risk is that we are in an environment where volatility is more persistently higher than normal, at least until a broader resolution of the major policy risks is provided. Until that resolution is forthcoming, and we can be confident that volatility is receding more permanently, it will be legitimate to worry that its impact on growth could also be longer-lasting than normal,” mentions the report.