V. Recent Equity Market Developments and Implications

The peaks that were reached in various equity markets by mid-July followed a sequence of gains dating back to the early 1980s, in most cases broken only by shortlived setbacks. While there were sound reasons to believe that these longer-term trends in various markets represented a response to improved fundamentals, for example, the drop in inflation (Blanchard, 1993), by the late 1990s many of these markets appeared to have reached levels that were difficult to rationalise. Part of this process seems to have been driven by extrapolation of then favourable trends in earnings as well as increased investor complacency regarding risk. The declines that occurred in the third quarter appeared to be the result of a downgrading of earnings projections and a reappraisal by investors of the risks inherent in these markets. Much of this seems to have been triggered by the spreading and deepening financial problems in emerging economies.