With central banks forging blindly ahead, currency stability may well be on its way out, warns Didier Saint-Georges
Dealing with paradox has long been fairly routine for investors. Although economic growth in the past ten years had yet to recover to its pre-2008 level - despite unprecedented central-bank intervention and rock-bottom interest rates - equity markets still managed to verge on record highs just three months ago.
That disconnect between economic reality and market performance was odd indeed. On the other hand, investors had little reason to wonder why it was continuing, given that a self-fulfilling prophecy was at work: the less the real economy responded to monetary-policy support, the more central banks needed to step up that support - thereby driving share prices even higher.
Then along came an unprecedented external shock. Virtually overnight, half of the world’s governments put their economies into deep freeze, acting on a commitment to protect their populations from infection by a dangerous virus."
Then along came an unprecedented external shock. Virtually overnight, half of the world's governments put their economies into deep freeze, acting on a commitment to protect their populations from infection by a dangerous virus. Spooked by the looming economic disaster, equity markets initially underwent a severe correction. In global terms, stocks lost anywhere from 30% to 40% of their value in one month. But what has happened since?
More than ever, governments and central banks have been compelled to sustain economic activity or to try to stave off irreversible damage to businesses and the income of consumers. It seems doubtful that such massive support can be increased much further, once the crisis is over, such to re-ignite the growth story in any serious way. Moreover, no one can predict when the pandemic will start to become a fading memory.
It looks rather like we'll have to get used to living with it for a while, which means adopting a cautious approach to our everyday movements, travels and leisure activities.
Companies will certainly think twice before investing further and hiring staff. Their priority going forward will be cleaning up balance sheets weighed down by the loans they have taken out in order to survive the lockdown. Employees in turn will most likely be spending their money more frugally out of a legitimate fear that they may soon be out of a job, if it has not happened yet.
So the question is this: given that economic growth has collapsed, and we can't realistically expect more than a slow recovery, why have the world's equity markets just shot back up by over 20%? Because paradoxes die hard, that's why.
At this point, governments and central banks have no other option than to forge blindly ahead. Central banks must now expand their purchases to include assets other than government bonds in order to guarantee low interest rates. In the process, they are encouraging economic agents as never before to borrow as much as they need. Governments, meanwhile, are forced to bid farewell to the fiscal responsibility mantra. So how could you not conclude that such massive support is good news for stock valuations?
If debt ceases to be a source of danger now that it is directly or indirectly underwritten by central banks, if business failures become a rarity thanks to government intervention, and if jobs are subsidised to a large extent, then the cost of risk simply goes away. If all a company needs to do is borrow money to pay its workers and if its share price is barely conditioned by actual earnings, then equity markets can basically defy the laws of gravity. To paraphrase Ivan Karamazov, if market rules don't exist, everything is permitted.
However, this thought exercise necessarily comes up against real-world constraints: sooner or later, the wealth effectively produced by an economy gets reflected in the intrinsic value of its currency. And that is most likely where to look for an eventual awakening from the dream of defying gravity.
Didier Saint-Georges is a member of the Strategic Investment Committee at Carmignac, Paris