Published on 10 July 2020

SUSTAINABLE FINANCE

Financial markets continue to rise, contridicting the reality of the global economy

The economy is collapsing, American unemployment figures are skyrocketing, and business prospects are poor…and despite it all, financial markets are soaring. Backed by stimulus packages and new money injected into the system, stock markets seems to be in a rapid recovery. This is a risky assumption considering the possibility of a second-wave pandemic that could put the brakes on global activity.

Ouverture NYSE bourse coronavirus BryanRSmith AFP 01
Global stock markets rose during lockdown after falling drastically in March.
@CCO

At the beginning of March, stock markets abruptly plunged as most countries went under varying levels of lockdown. In April, financial markets began to recover so significantly that at the beginning of June, the main global stock market indices almost returned to pre-crisis levels. It was only fear of a second-wave pandemic and mixed-signal messaging from the Federal Reserve that caused the markets to relapse around June 11th. However, this drop was only temporary and stock markets rose again very quickly.

Yet the real economy has come to a standstill. The Banque de France announced a 10% drop in GDP for 2020. Jerome Powell, the chairman of the Fed, declared before the Senate on June 16th that a "decline in GDP this quarter is likely to be the most severe on record". Gita Gopinath, Chief Economist of the International Monetary Fund (IMF), announced in a blog post that "the forthcoming June World Economic Outlook Update is likely to show negative growth rates even worse than previously estimated".

A striking divergence

The state of global financial markets has not ceased to surprise and worry. "We see striking divergence of financial markets from the real economy, with financial indicators pointing to stronger prospects of a recovery than real activity suggests," said Gopinath. Investors themselves are wary of the stock market’s dynamism. According to Bank of America’s monthly international investors survey, 78% of respondents believe the market is overvalued.

This is probably due to the monetary policies of global central banks, which injected massive amounts of money into the markets from the start of the health crisis. Most governments have also announced economic plans that allowed businesses to take a step back during the crisis, followed by stimulus packages, in an attempt to accelerate recovery. Thus, investors are betting on this rescue package, which is essentially providing insurance for their investments.

Some investors have even taken advantage of this "insurance" by investing in companies under great difficulty. American car rental company Hertz saw its share price take off soon after filing for bankruptcy on May 25th. This was the same scenario for other bankrupt companies, such as J.C. Penney, Whiting Petroleum and Chesapeake Energy. Investors who have invested in these companies are betting on short-term success and reselling their stocks before possible collapse, or the possibility that these companies will be saved.

A risky bet

It’s a very risky bet. "This divergence may portend greater volatility in financial markets”, warned the IMF Chief Economist. “Worse health and economic news can lead to sharp corrections". A second wave of the current epidemic could knock down this house of cards.

Means do exist to guard against such volatility. Sustainable finance, which makes it possible to consider a company’s strategy over the long term by taking into account environmental, social and governance (ESG) criteria, can detect the most robust companies. According to Trevor Green, Senior Portfolio Manager at Aviva Investors, the Covid-19 crisis has allowed them to test company resilience. He wrote, "were they well prepared for a possible crisis? What is their capacity to adapt? Did they react quickly to ensure the safety of their staff, their suppliers and their customers? The answers to all these questions allow us to obtain a lot of useful information, especially regarding ESG factors”.

Arnaud Dumas, @ADumas5


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