Climbing the wall

Global equity markets have been scaling the proverbial "wall of worry" for the last couple of weeks. Most major indexes are in or close to correction territory (falls of 10 percent or more), with the gains for the entire calendar year to date wiped out in the space of just a few sessions.

Looking around the world, maybe it's hard to be surprised by this.  Sanctions on Russia, in response to the crisis in Ukraine, are weighing on already-weak European economies; ISIS/ISIL is threatening a conflagration in the entire Middle East;  there are signs that the momentum in the Chinese economy has waned, which will inevitably rekindle fears over the solvency of the country's financial system; and now there's ebola, which could deliver a major hit to global growth if it were to get loose in one of the major economies.

Only the last of these is really new, however, and should not prove to be a major drag on growth unless the health authorities in the developed world really are as inept as they've seemed at times in the past couple of weeks.  (Yes, we do mean you, Texas Health and the CDC). The other negatives have been known for many months, and yet markets had continued to move ahead regardless, until just recently.  So what is it that's changed?

The factor that many analysts are choosing to focus on is the fall in oil prices.  As an explanation for the current weakness, this needs to be treated with caution.  Although the IEA has revised its crude oil demand forecast down slightly in recent days, it still expects demand for the year as a whole to be higher than a year ago.  The signs of slowdown in the global economy are not so severe as to suggest that the anticipation of falling oil demand is behind the price weakness.  Rising oil production, especially in the US, seems to be the root cause.

Is this really a negative for the US and other countries? It may weigh heavily on the share prices of oil companies (and it's potentially damaging for the oil patch here in Canada, with its abundance of expensive-to-produce crude), but it's a boon for the profitability of truckers, airlines and a whole host of other energy consuming sectors.  And it's an even bigger boost for consumers, who are likely to see lower prices for gasoline, natural gas and even groceries in the coming months, which should stimulate real consumer demand.

If energy is not the main negative, then we're left to assume that the key factor may be the looming removal of monetary stimulus in the US and elsewhere -- what one analyst in the linked article refers to as "monetary morphine".  The rise in equity markets in the past couple of years has always seemed out of line with the underlying strength of the global economy, fuelled by cheap money rather than real optimism about the outlook.

The big question now is whether the fall in equities will spook the Fed and other central banks into halting or even reversing their plans to unwind monetary stimulus -- a "Yellen put", if you will.  The even bigger question for the longer term is whether failing to return monetary conditions to something more normal will set the stage for a rerun of the 2008 financial crisis, or something even worse, not too far down the road.