An end to market turmoil or calm before the storm?

The financial markets appear to have settled down into an uneasy calm. Does this mean that the current period of turbulence is over and that all the gloomy forecasts of what it might mean are wrong?

The answer to that is a definite maybe. Certainly the international stock markets have settled down after taking a heavy knock earlier this week. And it may be that the worst is over. But investors who buy and sell shares remain highly nervous and further sharp swings in the value of international share prices could well be on the cards. After all, the crises in Russia and Asia, which are blamed for the latest bout of market nerves, have not gone away. There are enough uncertainties there to keep things on edge for a while yet and trading yesterday was very nervous.

Isn't a more definite forecast for the market prospects possible?

I'm afraid you have to pay your money and take your choice. Even the best brains in the US investment banking community, who spend their lives and make their living out of the market, are deeply divided on the outlook for shares.

Why the division of opinion?

There are plenty of quasi-scientific ways of coming up with a value of what a share should be worth on the market, mostly based on the outlook for corporate profits and the like. But at the end of the day the price of a share is what someone is willing to pay for it. The crucial factor in recent weeks is that investors who were happily piling into financial markets in most of the developed world in the early months of the year have now become much more cautious. For months arguments that share prices had climbed far too high were ignored by investors. Now, suddenly, the risk they are taking in making their investments is uppermost in their minds, having been ignored over the past couple of years as stock markets on both sides of the Atlantic just seemed to head higher and higher.

Is this fear of taking a risk due to Russia and Asia?

Partly, yes. Just over a year ago the Asian crisis started, with one currency after another attacked by speculators who started to question the fundamental health of the economies concerned, the wisdom of their investment policies and the health of their financial structures. As Asian economies collapsed like dominos, the West took a fairly relaxed view. Investors reckoned that cheap imports from Asia would help to keep down inflation and that big economic blocs like the US and Europe could continue to grow regardless. But in recent months the crisis has appeared to spread. First Japan, an economic casualty for some years, faced a collapsing financial sector partly due to the events affecting its Asian neighbours and partly to a long period of poor economic performance. Then investors, fearful that more economies could go the way of Asia, started asking where would the next emperor with no clothes appear. Russia was the answer, with the collapse of the rouble highlighting an economic structure in danger of complete collapse.

But how is it all connected?

In two ways. First, in the minds of investors, what happened in Asia slowly led them to take a more critical approach to looking at the risk of their investment. Suddenly they regained the ability to become scared and edgy and market sentiment took a turn for the worse. Second, there were also some economic ways that crisis became contagious. Falling demand in Asia has contributed to lower prices for commodities such as oil, which in turn has hit big commodity producers like Russia and some Latin American countries. Also, slumping Asian markets have hit companies exporting to this area, such as some of the big computer multinationals. Finally, as finance is global these days, a crisis in any one Asian country hits banks from all over the world, while financial institutions have been heavily caught in Russia.

So where does the biggest danger lie?

A Wall Street collapse would be the clearest threat to the world economy. This is because the US public has a huge amount of money tied up in the market - shares account for some 39 per cent of US personal wealth - and a major fall in the market would lead the US consumer to retrench by saving more and spending less. Millions of US citizens have banked on the market to build up their wealth and pay for their retirement and if they are forced to reassess their position, the results will not be pretty. The kind of fall in prices seen so far will not, forecasters believe, have a major economic impact. A 20 per cent fall in the market would knock 0.2 of a percentage point off the US growth rate in year one and just more than 0.6 of a point in year two, forecasters believe. So far, the US market is some 15 per cent off its peak for the year, so the effect on economic growth should not be enormous. But if the market spirals lower, this could have a much bigger impact on growth.

Any other risks?

The other danger is that further market falls and the collapse of more economies - many in Latin America are now facing severe pressure - could put a massive squeeze on the international financial system. If banks are forced to write off large amounts in loans they will be able to lend out less which in turn would slow growth and lead to more bad debts. (Already many banks in the West have written off hundreds of millions of pounds lent to Russia.) This has led some to warn of a liquidity crunch, although things would have to get a lot worse before this becomes a realistic threat.

So to sum up?

We are likely to face more market volatility in the weeks ahead. So far, the crisis does not appear to pose a major threat to international growth (with the exception of Asia, of course) but it could point to some slowdown. There is still a risk that a further Wall Street collapse or the spreading of the crisis to more economies in Latin America and Eastern Europe could put the international growth outlook at serious risk .