The power of stock markets on the up

The global stock markets are jumping from one all-time high to another. They have more than quadru­pled since the crash in 2007/8, corre­spon­ding to an annual return of more than 13%, and they have even escaped the coro­na­vi­rus crisis almost unscathed.

Share prices are now up a good 20% on their levels before the crisis. Measu­red from the lowest point, prices have increased by more than 82%, almost doubling within 15 months (see Fig. 1).

The coura­ge­ous inter­ven­tion of the central banks is one of the major drivers of this trend: in the wake of the finan­cial crisis, they redu­ced their base rates (some­ti­mes even into nega­tive terri­tory), provi­ding the markets with enough liqui­dity through to the present day. Over the course of the coro­na­vi­rus pande­mic, many central banks even increased their expo­sure, leading to a doubling of their total assets in the US and Europe (see Fig. 2).

In prin­ci­ple, this approach can be contin­ued inde­fi­ni­tely, with no time limit. If the addi­tio­nal liqui­dity remains in the finan­cial markets, this will lead to infla­tion (conti­nuous price increa­ses) on the stock markets, albeit not in the real economy. Share prices will head northwards, while the economy under­goes mini­mal growth or even expe­ri­en­ces a crisis. The finan­cial markets are decou­pling from the real economy, as it were – crea­ting a bubble. What remains are higher share prices and increased central bank total assets.¹

The expan­sio­nary mone­tary policy is expec­ted to conti­nue and the low inte­rest rate envi­ron­ment to hold firm. Stron­ger in times of correc­tions and crises, and less intense in peri­ods of econo­mic boom. Share prices should thus conti­nue to receive a tail­wind. Howe­ver, in contrast to the past, we expect crises and correc­tion phases to occur more quickly and with more fero­city, some­thing we have alre­ady seen during the coro­na­vi­rus crisis. Within a short space of time (23 days), the global stock markets lost more than 35% of their value. Such a rapid price loss is unique in the history of the finan­cial markets. This can be explai­ned partly by the swift increase in syste­ma­tic trading strategies2, which act on the finan­cial markets auto­no­mously free of emotion – and at light­ing speed.

What could bring an end to clim­bing prices?

An exoge­nous shock, such as another wave of the pande­mic, would affect the finan­cial markets only in the short term. Like the previous waves, this wave would also be flat­tened by injec­ting more liquidity.

In a sustained crisis on the stock market, a trig­ger is needed that reins purcha­ses in and/or pushes inves­tors to sell their secu­ri­ties en masse. This could take the form of a poli­ti­cal decis­ion that rest­ricts the central banks’ purcha­sing program­mes, or even brings them to an end. But as these banks are inde­pen­dent (or at least, they should be), this scena­rio seems unli­kely. Conver­sely, if inves­tors were to panic-sell their secu­ri­ties, infla­tion would pass from the finan­cial markets to the real economy. Central banks would be forced to increase their base rates to stem the tide. Credit would become more expen­sive and the economy would suffer. At the same time, share prices, alre­ady drif­ting lower, would fall, leading to a finan­cial and econo­mic crisis.

These scena­rios are extre­mes and it’s true that they rarely appear suddenly and with great force. That said, we think small-scale move­ments in either direc­tion are more proba­ble. In order to protect a port­fo­lio from as many rough patches as possi­ble, it is important to have a wide range of assets. Invest in diffe­rent stocks, sectors, regi­ons and curren­cies. Add real estate stocks and/or funds and gold to your port­fo­lio and avoid long-term bonds when inte­rest rates are histo­ri­cally low.3 Main­tain liqui­dity reser­ves that are suffi­ci­ent to cover current and future expenditure. 

Would you like to know more about the indi­vi­dual and opti­mal allo­ca­tion of your foundation’s assets? 

Talk to your bank.

¹ In addi­tion, govern­ments also laun­ched econo­mic stimu­lus packa­ges to an unpre­ce­den­ted extent during the coro­na­vi­rus crisis. This invi­go­ra­ted the real economy and has led to increased natio­nal debt.

² These are compu­ter program­mes that auto­ma­ti­cally trade secu­ri­ties on the exch­an­ges accor­ding to certain patterns.

³ If infla­tion and inte­rest rates increase, bond prices will decrease. This asset class thus has a poten­ti­ally high risk of loss for investors.