Have the financial markets gone mad?

► “They anticipate changes in the economy”

Yann Azuelos, responsible for the financial management of Banque Mirabaud

The heights reached on the financial markets can really surprise in the current context. In principle, the worsening of the health situation should weigh, with the spread of the Omicron variant. This is not the case. Financial markets completely exclude it from their analysis grid. They believe that the situation is handled quite well, that we have learned from the past, that governments are able to make decisions very quickly and that economies are able to adapt.

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For the markets, the health crisis has rather had the advantage of accelerating both the digitization of businesses, with teleworking in particular, and productivity gains. But there have also been losers from this shift in the economy, particularly with everything related to the hotel industry, leisure and tourism in general.

Not all stock market values ​​have risen. Traditional airlines have been more affected than low cost airlines, which are more focused on short flights. Some auto industry players, who didn’t switch to electrification quickly enough, also suffered. Even in 2022 this dichotomy between losers and winners should continue quite strongly.

Nonetheless, there are concerns about inflation, announcements of interest rate hikes, particularly in the US, as well as the prospect of less accommodative monetary policy. If we balance all of these elements, there should logically be a decline in the equity markets. Markets aren’t crazy, but they reverse the principles we’ve learned in traditional economics textbooks.

This is mainly due to the communication from the US central bank, which is well managed and has prepared investors for the changes to come. The monetary authorities explain that their policy is mainly aimed at calming the current strong growth somewhat and that the surge in inflation is mainly due to the very rapid recovery of activity.

As a result, the expected rise in interest rates has already been acted upon by investors who prefer to see the glass half full and anticipate changes in the economy. Visibility is good on growing companies and on the sectors that will benefit from the massive recovery plans. This is why investors are ready to buy stocks that are expensive anyway, which drives the stock market up. The fact that the European Central Bank is not expected to raise interest rates this year will also support prices.

According to our scenarios, the markets should therefore remain generally bullish this year, with volatility, however, precisely linked to the change in monetary policy and uncertainties about inflation.

► “Markets are both amnesic and shortsighted”

Domenico Plihon, emeritus professor of economics, member of the Economistes terrés

There is a logic in the good health of the financial markets, it is that of financial capitalism. Markets operate on expectations. Profit prospects drive prices up: shareholders anticipate profits, and therefore dividend payments, and then continue to buy, which supports good market performance. Current expectations are based on record earnings in 2021, with record dividend payments that markets believe will continue.

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The markets are also supported by the numerous mergers and acquisitions that have taken place in recent months. Companies that do well buy more, usually offering a higher price at the moment, which has the effect of boosting markets. We are also seeing a massive wave of share buybacks – companies buy back their shares to drive prices up, for the benefit of their shareholders. The system turns on by itself!

Paradoxically, public policies play a central role in the current phenomenon. The climate is very favorable to businesses: the markets know that the States will come to their aid, without even imposing conditions on this support in terms of employment or the environment.

Another major player in the current boom in financial markets: central banks, which have created money to help businesses and the stock market. They bought massively public bonds to finance public debt, but also private bonds to support the markets, in the hope that this would revive economic activity. But since the economic activity was not very dynamic, this money was not used in economic life in the form of investments and is available on the financial markets.

→ ANALYSIS. Inflation is on the rise across Europe, but unevenly

For the moment, therefore, everything is fine and we continue. Only the trees never go up into the sky and that we will probably face a stock market crisis. There is a collective psychological effect on the markets, which means that as long as most players believe prices will continue to rise, they keep buying stocks. This “irrational exuberance”economists speak of, it can change very quickly thanks to an accident or a change of policy.

Central banks will probably raise interest rates one day due to inflation, there will be adjustments that could lead to slumps. These phenomena have already happened, but the markets are not learning from the past. They are both amnesic and nearsighted, insofar as only the short term matters. Keynesian economists, myself included, talk about it“disaster blindness”.

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