An Absurd Exuberance Continues in The New Year
Yopie Hidayat (Contributor)
THE year of 2020 might just be the most absurd year in global financial market history. An anomaly appeared during the pandemic. The tenets of investment changed entirely. The financial market not only survived the greatest economic crisis of all the time, it was even engulfed in irrational euphoria.
The market should, more or less, reflect the fundamental conditions of the economy. If the economy is healthy, the price of various financial assets will be higher, which reflects that condition, and vice versa. But the reality of 2020 has just been the complete opposite.
The world economy is in a slump due to the pandemic. Covid-19 has infected 76.8 million people so far and taken 1.7 million lives. Virtually all countries, big and small, rich and poor, have been dragged into recession. Innumerable businesses had gone belly up and millions workers had lost their income.
But that devastation only showed up momentarily in the markets, at the start of March. After that, investors have been swept up in an inexplicable optimism. The prices of various assets, such as government bonds issued by developed world and backwater countries alike, corporate stocks both bona fide or sketchy, and cryptocurrencies such as Bitcoin, all have skyrocketed to insane heights.
In the United States, the total value of all initial public offerings throughout 2020 has reached a record of US$175 billion. Emerging economies also record high bond sales both in US dollar and euro, totaling equivalent to US$730 billion in value. Investors took on those assets with no exceptions.
It is as if the market no longer cares about the risk. This is the central tenet of investment that has been abandoned. Many zombie companies still exist, even though they are unable to pay for the interest of their own debts. They are not dead yet simply because of the government’s stimuli. Yet, the stock’s price of these zombie companies still rises up.
The main sources of market euphoria are central banks around the world, powered by the Federal Reserve. Central bank leaders are now casting the same spell: save the market whatever it takes. The required financial support for it only comes in one size: unlimited.
From this policy, a massive flood of liquidity has come in unimaginable amounts. They also come with nearly zero interest. The Fed, for example, printed US$120 billion per month in liquidity which flowed into the market since March. This abundance of cheap money has buoyed investors around the world.
How does this story end? What goes up must come down. That is the unanswered trillion dollar question. Analysts are trying to find justifications for that irrational exuberances. One explanation is that asset prices are still not too expensive in a long-term perspective.
The presence of big tech companies is also another explanation. Amazon, Apple, Google alike have enjoyed the fundamental economic shift due to the digital disruption. This sector has become the main driver of market enthusiasm. Technology stocks are responsible for 55 percent of the increase in the S&P 500 index for the last 12 months. So, what price bubble are you talking about?
However, there is one crucial factor. The last deciding factor of this absurd episode is the movement of interest rates. When the time comes and the economy returns to normal, inflation will return and with it comes higher interest rates, back from its near death state in the negative grave.
If the market were a plane flying high, the super low interest rate would be one of its main engines. When that engine is suddenly off, there is still no scenario in which central bank governors can take hold of the situation. Can they make the plane glide into a soft landing? Or will the financial market crash into pieces?
The end of this story might not be coming next year. Many analysts are convinced that interest rates will not be going up in 2021 as the economy has yet to fully recover. And until it does, central banks will keep the liquidity flowing. And thus the irrational exuberance may continue in the market, for no one knows how long. Happy New Year.