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Perception, not profit, dictates market mood
US stocks retreated slightly last week after abrupt changes in market perceptions of the Federal Reserve, biotechnology stocks and German car makers.
This week is likely to see more volatility as traders await inflation and jobs data that could decide the timing of the on-again, off-again 2015 interest-rate hike. Shares plunged early in the week as the Fed's mixed signals caused a crisis of confidence in the central bank, and recovered somewhat on Friday after assurances from Fed chairwoman Janet Yellen that the plan to hike rates this year was still intact. To anyone who has followed markets in recent decades, the idea that stock-market bulls were reassured by the threat of higher borrowing costs is a new paradigm.
Traders had feared that the Fed chairwoman and the other committee members postponed hikes in anticipation of a global recession, and warnings from machinery giant Caterpillar. Fear was at large in the stock market last week, moving from stocks with Chinese exposure to sectors that had thrived for most of this year.
Market crises often arise when traders' attention is diverted elsewhere. Remember the Grexit? As recently as July, the ability of Greece to cling on to its place in the eurozone was supposed to be the biggest threat to the global financial system. Now, it's not even the biggest problem facing the eurozone, or, for that matter, Greece. Some observers say nationalistic responses to mass migration of Syrian and African refugees to Greece and other southern European nations is a bigger threat to the future of the EU project than Athenian finances ever were.
A couple of weeks ago, all that mattered was the stability of China's stock markets and economy. But Chinese and US stocks barely budged last week when the Caixin purchasing managers index, a survey of Chinese manufacturers, registered its worst reading since the Great Recession.
Apparently, while traders were worrying about all the overseas trouble, a speculative bubble was building up under their very noses.
More than a year ago, the Fed boss had warned that the valuations of biotechnology stocks were "substantially stretched". Ever since, parallels between the makers of drugs that interact with people's genetic makeup and the dotcom companies of the early 2000s have occasionally surfaced. As in that era, the bears on the sector point out that the vast majority of companies rushed onto the stock market in initial public offerings have never generated so much as a dollar in profit. As in that area, bulls on the sector point to the massive potential profits - this time, pointing to the biotech drugs already approved that can sell for US$750 a pill or more.
Those lofty price tags ended up popping the bubble. What looked like potential profit now looks like a stigma.
How did that sudden change in perception came about? You couldn't make it up.
The New York Times ran a story about a pharmaceutical-sector investor called Martin Shkreli who bought the rights to a drug that treats a common AIDS complication and then jacked up the price more than fifty-fold to US$750. Nobody in the financial world took much notice of the story.
All it took to pop the biotech bubble was less than 140 characters from Democratic presidential candidate Hillary Clinton. One tweet took down the stock market.
On Monday, Mrs Clinton tweeted a link to the NYT story, vowing to draft a proposal to stop such "price gouging". By Friday, the iShares Nasdaq Biotechnology exchange-traded fund, which tracks the performance of the largest Nasdaq traded biotech companies, had fallen more than 13 per cent, and many smaller biotech companies had fallen by twice as much.
Analysts at brokerage Morgan Stanley said it was highly unlikely that Mrs Clinton's proposal to rein in the drug prices would ever become law. But they also acknowledged that Mrs Clinton's tweet may have changed the perception of the sector's promise forever.
In a volatile market, selling can beget selling. Just ask investors in the oil, commodities and emerging-bond markets. Or investors in German car maker shares.
In a scandal that rocked faith in German engineering, Volkswagen admitted to cheating on emissions tests in the US. VW likely gamed tests in Europe, and suspicions are mounting that its compatriot, BMW, did the same thing. Like the pop of the biotech bubble, the selling in the shares of the car makers has more to do with perception than profit.
Friday's jobs report is expected to show the addition of around 200,000 jobs. If a surprisingly strong jobs report coincided with strong consumer inflation data earlier in the week and the jobs could force the Fed's hand as early as October. That would come as a relief to most traders as the apparent confusion inside the central bank is perhaps the market's biggest fear of all.
"I think it's the uncertainty more than anything else; I don't think the mere action of a hike is going to derail the market," said Matthew Kaufler, a portfolio manager at Federated Investors.