What’s going on in financial markets?

Stock market values have been heading back up for a couple of months despite the rapid spread of the coronavirus around the world and the worst US street protests for half a century. The US benchmark S&P500 index of leading companies is on course for its best quarterly performance for 82 years while the Nasdaq index, which measures technology stocks, reached an all-time high on Tuesday in New York. Shares in the UK, Germany, Asia and Australia are all up strongly as well.

But I thought they were all going to hell in a handcart because of Covid-19?

Well, they were. The onset of the global coronavirus pandemic in early March precipitated some of the biggest stock market falls for years. Hundreds of billions of dollars were wiped off the value of companies all around the world as it became clear that the virus was going to stop the global economy in its tracks and see millions of workers laid off as industries such as aviation and tourism were reduced to a shell overnight. But the markets, driven by Wall Street as usual, seem to think that the worst is over.

So what happened?

By the second week of March the US central bank, the Federal Reserve, had seen enough. It decided to pump $1.5tn dollars into the financial system, consisting of buying up government bonds that no one else wanted to buy, direct loans worth billions to struggling companies and also circumventing legislation to hoover up the debt of risky companies as well. The policy driven through by Fed chairman Jerome Powell paved the way for massive intervention from other central banks across the world, such as in Australia, where the Reserve Bank embarked on quantitative easing – or money printing – for the first time. These measures have basically saved the day, along with huge fiscal stimulus from governments including state-funded wages schemes for furloughed workers, such as in the UK.

This policy worked after the global financial crisis, didn’t it?

To an extent. The post-Lehman intervention was massive and paved the way for a decade-long boom but it continued the cycle of reliance on debt and we never really weaned ourselves off it. This current market intervention is even bigger and risks extending what many experts saw as an unsustainable cycle. It has essentially underwritten risk in the markets and investors have seen this as a sign that governments will do whatever it takes to prevent large falls in the stock markets – a kind of proto-nationalisation of the global economy. Hence money has poured back into stocks despite many companies being on their knees.

Angus Coote of Jamieson Coote Bonds in Melbourne said metrics used by analysts such as the earnings per share of companies showed that money had flowed into indebted companies, indicating that the current wave of investment was especially risky. He warned that the mistakes of the post-2008 response were being repeated and that ordinary working people would end up bearing the costs. “It’s quite sickening to see Mr Powell bail out Wall Street types at the expense of the man on the street,” he said. “Socialise the losses, privatise the gains. It’s not capitalism.”

So we are in danger of inflating another bubble here?

That is a possibility because so much new money has been created – only last week the eurozone doubled its support measures to €1.35tn – and it has to go somewhere. The feeling among experts is that if it is put to productive use, such as in infrastructure spending, or channelled into the pockets of people on low incomes who will spend the money in shops and on services, then the real economy might be rebooted on a more sustainable footing. But if it is simply passed to investors to inflate the prices of assets such as shares and property, knowing that the Fed will support the market if it turns sour, then we have simply doubled down on the problem.

Mohamed El-Erian, chief economic adviser of the insurance giant Allianz, says massive Fed support was not just propping up unproductive “zombie companies” but risks creating “zombie markets” which are so distorted that capital is not used properly. “It also adds to the disconnect between Main Street and Wall Street [and] worsens wealth inequality,” he says. Damien Klassen of Nucleus Wealth in Melbourne says the feeling that investors could not lose is stacked with risk and moral hazard. “It’s OK if the money created by central banks goes into productive things like infrastructure but it has no value if it goes into bidding up asset prices. That’s where the moral hazard comes in and that is where we risk inflating another bubble.”

But what about the recession we’ve heard so much about?

Good point. Just about every major economy is already in recession or is heading that way at a rate of knots. The World Bank said on Tuesday that its baseline forecast envisions that the world economy will shrink by 5.2% this year, the deepest global recession in decades. The current quarter is expected to be the worst but we won’t know how bad until later in the year, by which time unemployment will be peaking at well over 10% in many countries. On top of that, we don’t know what will happen when governments start to phase out the wage furlough schemes and people are left potentially without incomes.

So it might get worse again?

That’s a strong possibility because the current action on stock markets appears to be totally disconnected from the real world economy. “At the moment traders are thinking that this is as bad as it gets and it will get better,” says Klassen. “But they might have to start looking at the fundamentals at some point. They think it looks OK now but it doesn’t take into account the demand destruction or supply chain disruption that we’ve seen and that has to be rebuilt. Small and medium-sized business losses and job losses might become so great that the market can’t ignore it.”