Banking on it: A contradiction in terms

Banking on it: A contradiction in terms
02 June 2013

The performance of global stock markets in 2013 remains mystifying and it leaves me wondering how much longer in can continue. While the advanced industrial economies still struggle to recover from the global banking crisis, the financial markets have soared.

There is a rational explanation for the apparent contradiction, but it does not mean that the business outlook is necessarily bright. Very low interest rates are part of the explanation for current strong asset prices. This could be a risky policy stance that may be contributing to an emerging asset-price bubble.

Downturn and interest

The collapse of the Western banking system in 2007 to 2009 caused a bitter recession and a fall of 50% in world stock markets. Policymakers then responded with unprecedented measures to support economic activity. In the US and UK central banks cut interest rates to almost zero and pumped money into the economy. Under the policy known as quantitative easing (QE), they expanded the money supply by buying large amounts of government and corporate debt.

Throughout history, low interest rates are generally good news for investors. And for those invested in equities, the value of a company’s future earnings also increases. For the past four years, interest rates have been maintained at their lowest level in the 310-year history of the bank of England.

Pension investors

In today’s age, where politics and economics are so widely intertwined, the performance of financial markets matters hugely for the global economy. Anyone who contributes to a pension fund, sacrifices current consumption to secure future financial security and thereby literally has a stake in the market, which is quite a lot of us no matter how big or small our investments may be.

Current low interest rates may have inflated asset prices unsustainably and caused distortions. If, like me, you’re an investor with a stake in the market then you may very well be nervous.

At some point central banks will need to unwind their unorthodox policies.  This would enhance economic stability and enable businesses and investors to take longer-term decisions. Surely this would be a better foundation for prosperity rather than maintaining artificially cheap credit.

We’ve already seen the early signs of market volatility in recent weeks but I fear there may be a summer correction heading towards us.

What’s your opinion on the recent upturn in the UAE? Do you trust it enough to start spending again?


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