I recently came across the following quote: “Be careful not to compromise what you want most for what you want now.” It immediately triggered my thinking on the need to address economic issues in the long-term, rather than short-term. This applies to governments when managing the country’s economy, businesses when taking investment and marketing decisions, and to individuals when taking consumer decisions.

One particular area to which this quote applies is financial markets, and more specifically the volatility in financial markets. This volatility may be due to a number of reasons, many of which are very often short-term related. This leads analysts to assess financial markets every hour and take decisions just as often.

I often ask myself to what extent the movements in equity and bond prices, interest rate spreads, currencies, and the prices of commodities are really due to economic issues, and therefore reflect positive or negative economic developments. Or are they knee-jerk reactions to specific situations?

To paraphrase another quote I read, are we playing snap in financial markets when we should be playing chess?

When we speak of volatility in financial markets, we need to appreciate that it is not just volatility in stock market indices, but rather volatility in a number of areas. So when speak of the price of oil, for example, it is not just the price of the commodity, but also the value of the dollar, the currency in which oil is quoted, the price of converting crude oil into whatever product is required (such as petrol, diesel or kerosene), and the cost of transporting it.

Are we playing snap in financial markets when we should be playing chess?

The currency also plays a role when we assess interest rate spreads and movements in the price of equities and bonds. Possibly one also starts to understand why some players in financial markets have developed algorithms to analyse all the data and then they trigger purchase or sale orders. One wonders whether these algorithms actually assess long term economic data or just short-term movements in prices ‒ therefore on what basis do these algorithms make these decisions.

My fear is that given the volatility (some use the euphemistic term, ‘correction’) we have had in financial markets during 2018 and the rebound we had in January 2019, it would seem that short term considerations are given more importance than long term considerations.

One does accept that this volatility is due to the perceived increased or lower risk on the part of investors. However it is pertinent to ask what these perceptions are based on. And we could very well be in a chicken-and-egg situation.

Is a perceived increased risk the result of a weakened economy or does an economy weaken because of a perceived increased risk. Which is the cause and which is the effect?

Irrespective of the answer, the financial markets just react, at times in an apparent irrational way. When this happens we can talk ourselves into an economic bubble or into a recession.

There is another consideration to be made. As long as it remains possible to make good profits by simply moving capital from one country to another or from one asset to another, without creating any economic value, volatility in financial markets will remain.

Going back to the quote I started off with, I fear that, when volatility in financial markets is not a reflection of economic fundamentals, we are willing to compromise what we need most (a strong economy) for what we want now (a quick buck).

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