Rising stock market valuations on the Atlantic’s both sides of are stoking concerns regarding an imminent correction as valuations hit levels that are not seen since the dotcom bubble and the eve of the crash of Wall Street.
Stocks are trading at levels that were only previously attained in the run-up to Black Tuesday and the year 2000’s tech collapse, causing concerns among economists that markets are doomed for a devastating reversal that would drive world economic growth off track.
“In both cases, sharp market declines followed these high readings,” Graham Hacche of the National Institute for Economic and Social Research (NIESR) warned.
Citing the cyclically modified price-earnings ratio or the Shiller CAPE ratio, increasing to more than 30, Hacche said that this meant that “markets may have become increasingly vulnerable to shocks,” which “could have significant negative repercussions on private consumption and investment.”
On Friday, one day after the Bank of England increased interest rates for the first time in a decade, the London stock market closed at a new record high of 7560.35. Meanwhile, US equities also concluded the week at record highs.
Hacche stated that markets were defenseless to a broad series of shocks, which could come from anywhere around the world.
“Markets are vulnerable not only to autonomous changes in sentiment but also to economic policies including policy failures and missteps,” said Hacche.
Extremely high interest rates could cause a crash, while unreasonably low rates could also produce a bubble, followed by a bust, said Hacche.
Cutting financial regulation, an obvious rise in protectionism – which could suddenly dent growth – a crunch in the debt markets of China and rapid tightening of monetary policy in the eurozone could also set off shock waves around the world and into US stocks.
Analysts at BNP Paribas are alerted to geopolitical risks and an increase in inflation, and thus interest rates. Even though there is no guarantee that stocks will sharply fall back, the analysts are watching for any “catalysts for correction.”
“With the US consumer having been reliant on wealth gains to drive down the savings ratio, an asset price correction could provoke a recession,” stated Paul Mortimer-Lee, a chief market economist.
He believes that as the global economy runs closer to its full capacity, the risk will increase, inflation increases and central banks modify their balance sheets.
Janet Henry of HSBC also warns that stock valuations in Europe and the United States “are not obviously consistent with the underlying performance of the economy.”
She believes that low interest rates will help maintain this. However, “lower growth, higher rates, or anything that alters the way the pie is being shared – such as an acceleration in wage growth not backed by higher productivity or changes in government policy relating to taxation, regulation, labour laws or even protectionism – could lead to a reassessment.”