Markets lose touch with reality — thank goodness
Financial market participants have watched in disbelief this week as asset prices have kept rising, while US cities burn, unemployment breaks records, a global depression becomes more likely and the coronavirus pandemic still rages.
The S&P 500 index is now less than 5% below where it started the year; corporate hybrid bonds are trading nearer senior paper than pre-crisis.
For the last decade, money printing by central banks has kept the market rising. It took a global pandemic to break the rally but now — in three months — the central banks have got that one sorted, too.
There is no sign of Atlas’s arms wobbling yet.
On Thursday, the European Central Bank slapped another €600bn of quantitative easing on the green baize table, and it clearly has more cards up its sleeve.
But the stakes are higher now. The divergence between a market dressed for The Ritz and an economy begging for pennies has never been wider.
To some, the market has become a parody of capitalism: so administered, so driven by technical factors that its mission of assigning prices to future cashflows and risks is a sham.
Central banks have painted themselves into a corner. By revealing that they can support markets — defending pension savings and companies’ access to capital — they have chained themselves to doing so. What benevolent deity would permit a financial recession if it had the power to avert it?
But such a rally can only ever be skin deep. Rather than saving the economy, policymakers have saved financial assets by divorcing their prices from reality.
Conventional wisdom implies such a vow to inflate asset prices can only have one outcome: the bursting of the ‘everything bubble’. Central banks are gambling on being able to rewrite the rules.
For capital markets issuers, the message is clear: get your difficult deals done now because it could get very messy.
Many understand this. Airbus and Danone this week returned for more bond funding, having issued in March.
In the banking sector, additional tier one capital has not been properly tested yet because spreads are still deemed too wide. In fact, the first issuer is likely to get a humongous book and reset spreads tighter, because investors are hungry for yield.
Even the most bullish of equity bankers are telling clients to sell stakes now, before the worst second quarter results in recent history are released.
But time is running out. Despite what policymakers like to tell us, they are running out of options. More fiscal spending is going to be difficult as budget deficits are already bulging.
More monetary easing is like pushing on a string if there is no actual demand for credit.
Yet however much markets induce vertigo, it would be wrong to rail at the central banks.
For emerging markets, the start of this crisis — it is probably still near the beginning — could have been so much worse if central banks had not turned on the firehoses of liquidity.
The fact that governments from Abu Dhabi to Guatemala have been able to tap markets so soon has helped to stave off a catastrophic credit crunch.
It is easy to forget how bad things looked in mid-March — when many EM government bonds were trading in distressed territory and money was pouring out of bond funds.
Asset price inflation is not the long-term answer to the world’s problems. But for now, this rally is buying valuable time.