LONDON (Reuters Breakingviews) - The financial world’s post-pandemic exuberance just might have passed its peak. After fuelling an astonishing rebound in stock and bond prices in the past six months, global investors are showing signs of caution. The NYSE FANG+ Index of 10 leading high-tech stocks is down 12% since Sept. 2, although it is still double its March low. The wider U.S. S&P 500 Index has fallen by 10%. Those declines could be a leading indicator of a calmer investment environment.
The woes of Nikola may be another sign of a more sensible world. The would-be maker of hydrogen-powered trucks had no product, yet was awarded a market capitalisation of $28 billion in June. After a highly critical research report from the aptly named Hindenburg Research, the founder has quit and the company’s market value has dropped to $8 billion.
That is still a lot of value to give a company that doesn’t have any revenue, let alone earnings. By contrast, Uber Technologies has lots of revenue, but $59 billion is still a lofty market cap for a taxi operator with no clear path to profitability. So is the $354 billion of equity value investors award to Tesla, which cut its own forecasts on Tuesday and was recently excluded from the S&P 500 Index because its electric cars have not yet generated sustained earnings.
Still, market selloffs have to start somewhere, and now might be a good time for investors to calm down. Economic trends remain mostly positive, even though some European countries are tightening restrictions in an attempt to stop the spread of Covid-19. A more normal economy might reduce the support for financial markets from monetary and fiscal policies. It might also bring more attention to the ongoing growth-sapping trade dispute between China and the United States, not to mention concerns about the effects of American political chaos.
Unfortunately, the long and winding road down to more normal conditions looks treacherous, for three reasons.
First, much of the global economy still benefits from widespread monetary and fiscal support. John Maynard Keynes was right: when economies are unbalanced, the only tools for keeping up spending and investment are governments’ fiscal deficits and central banks’ artificially low interest rates.
The post-lockdown imbalances remain large, especially in the travel, leisure and hospitality industries. Further restrictions on activity, such as those introduced on Tuesday in the United Kingdom, will extend the need for government programmes that substitute for wages and subsidise rents and mortgages. A fair portion of the cash created to pay for these stabilisers will inevitably leak into financial markets. That tends to push up asset prices, encouraging investors to crowd into the next Nikola.
Second, settled bad financial habits are hard to cure. Many observers would agree that interest rates are unhealthily low, corporate debt levels dangerously high, and stock market valuations wildly expensive. But in the short term, the continued use of dangerous monetary substances will cause less damage than a sudden stop to the stimulus.
The world’s authorities learned that lesson in 2008. The excesses of the American housing market had led to some serious local issues of overbuilding and over-leveraging, but the correction that felled Lehman Brothers prompted a deep global recession. The simplest way to avoid a new variation on that gloomy theme is to put off more than token monetary and fiscal tightening until some safer time, when there are no looming pandemics, no divisive elections, and fewer trade frictions.
Finally, many of the people and institutions with the most to lose from a normalisation of financial conditions have a lot of political power and intellectual influence. Count on private-equity barons, investment bankers and the think tanks they support to provide slick and rigorous warnings about the risks of moving too fast on raising interest rates and cutting fiscal deficits. Expect the politicians who mingle with the monied elite to listen carefully.
Just because arguments in favour of indefinitely continuing the new financial normal are self-interested does not mean they are entirely wrong. In theory, a steady flow of newly created money could keep bull markets going forever, supporting the fortunes of the already favoured.
However, risks rise along with asset prices. The economic dangers include squandering resources on Nikola-style froth and the sort of poor corporate governance that allowed Adam Neumann to become a billionaire while running WeWork, a loss-making property-rentals startup.
More generally, too-low interest rates can stimulate unproductive borrowing. Asset management giant BlackRock calculates that the ratio of investment-grade corporate debt to GDP in the United States is now five times higher than in 2001. The increased leverage could discourage job-creating investments. It almost certainly leads to structural financial fragility.
If the leverage produces higher earnings for shareholders and higher fees for private-equity fund managers, it will lead to even more abundant payments to a small and already affluent elite. This uneven division of the financial spoils invites greater political frustration from the less favoured majority.
Of course, popular threats to the position of the top 1% have been widely and inaccurately predicted ever since the 2008 recession. Still, increased inequality may be like the hydrogen Nikola plans to use to power its trucks: apparently safe, but potentially explosive.
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