Turning tail

Markets: Market sentiment can be fragile. For months, investors on both sides of the Atlantic were not too worried — and then they suddenly were. Major stock indices in Europe and the United States have fallen by 7 per cent in a fortnight, dropping sharply on Thursday. Despite the absence of a significant single shock, there are good reasons for the darker mood.

The first is economic. A recovery has really arrived, but it still looks anaemic. Poor US employment data were among the triggers for Thursday's sell-off. The most recent GDP figures for the UK showed Britain is only crawling out of recession. German manufacturing orders are also down. Meanwhile, strong-looking corporate profits have been driven mostly by cost-cutting, rather than revenue growth.

Support from central banks and governments is also drying. The Bank of England's decision to put its money-printing operation on hold was expected, but the market will miss a buyer which has spent about £200 billion on UK government bonds in a little under a year.

The European Central Bank and the US Federal Reserve are also slowing their emergency programmes, while China is trying to tighten monetary policy. Even Western governments, the spenders of last resort throughout the crisis, are no longer able to throw cash around. The emphasis now is on cutting back spending and tackling deficits.

Meanwhile, the economic future looks darker. It is still unlikely that Greece will default or be expelled from the euro zone — but a little less unlikely than it did a few weeks ago. Sovereign jitters have spread to Portugal. Spain might be next, and a fiscal crisis in Britain or the United States cannot be ruled out.

All this does not bode well for the banks, which have been the main beneficiaries of the monetary pump-priming, and which still account for a large chunk of the capitalization of Western stock markets. Of course, sentiment could easily turn. The economic news could improve again, or the authorities could conclude that the outlook is so bleak that more money needs to be sprayed at financial markets. But for now, investors have stopped ignoring the warning signs.