The stock market bubble faces piercing inflation.
KARACHI:
A relentless rally in global equity markets has come to a screeching halt of late as investor fears materialized over stock valuations.
With coronavirus infection rates rising and the virus mutating in addition to delays throughout the vaccine supply chain, particularly in third world countries, an uneven recovery can at best be expected in the form of K.
Lately, US indices have hit new highs. Many stocks were trading at incredibly high valuations; for example, Tesla Motors stocks at a price-to-earnings ratio of over 1,000, despite falling 30% from its top.
Value investors are warning of the looming tech bubble, which could burst at any time, destroying the entire US market due to its higher weighting.
The whole premise behind the illusion that this part of the stock market will not over soon be mainly due to a very accommodating stance taken so far by central banks worldwide, which have inflated asset prices disproportionately.
Post-COVID-19 global retail rally points to excess liquidity and easy access to markets. The rise of zero commission brokers in the United States fuels irrational exuberance, which is the hallmark of all cycles of expansion of stock markets.
To get the perspective, the meteoric rise of GameStop stock 1000% north at the New York Stock Exchange, in total disregard to any fundamentals, by the so-called “Reddit Army” is mind-boggling and is being investigated by the Securities and Exchange Commission.
Despite JP Morgan’s recent disagreement with value investors about the presence of any bubbles, the risk of a sudden and sharp rise in inflation is looming more extensive than ever in history.
With surging commodity prices since hitting the lows during the pandemic – West Texas Intermediate (WTI) crude at $69 per barrel (+280%), copper at $4.12 per pound (+200%), coal at $83 per ton (+68%), etc. – the situation can spiral out of control faster than anticipated.
European Central Bank President Christine Lagarde cautioned last week that rising interest rates posed a risk to the broader financing conditions, forcing central bankers worldwide to turn hawkish in their monetary stance prematurely.
Fault lines have already started to appear in stock markets with the recent sell-off in growth and tech stocks as the yield for 10-year US bonds suddenly rose above 1.6%, causing widespread chaos in the interest-rate-sensitive and overvalued tech sector.
The risk of rising volatility in western markets, especially in the US, has set off alarm bells across the globe since they are interconnected in one way or another.
Recently, China’s Banking and Insurance Regulatory Commission Chairman Guo Shuang warned reporters that there was a bubble in foreign financial assets, which may burst any time and cause severe Chinese market volatility.
Back home, the relentless rally of the KSE-100 index post-Covid showed signs of exhaustion with the loss of 4,000 points (-8.5%) after hitting the 47K level, seen as a strong resistance that the market was not able to to to break above in April 2018.
Thanks to rising oil prices, the rally, mainly led by the construction sector and supported by exploration and production companies’ stocks, is getting ahead of itself with the heightening political tensions.
Also, the circulation of news on social media about the withdrawal of tax exemption from mutual funds made investors jittery. A 42-basis-point rise in the cut-off yield on three-year Pakistan Investment Bonds (PIBs), auctioned recently, as well as the recent Consumer Price Index (CPI) data point to a higher inflation scenario.
Despite the State Bank of Pakistan’s forward guidance for a gradual transition, the situation can quickly spiral out of control due to supply disruptions in the commodity space and a sudden rise in pent-up demand post-COVID-19.
Although the stock market is not tech-savvy (read: heavy) or overvalued, the contagion of the sell-off abroad or strategy to book profit in the construction sector and rotation in the banking sector may intensify mitigate the risk of the rising interest rate.
