BMany observers are concerned about the growing divergence between rebounding equity markets and collapsing economies. The paradox is spicy but should no longer surprise anyone: conceptually, the level of the markets does not pretend to reflect the performance of the economy, but only to give it a “price”.
Now, in a liberal economy, the price of everything is nothing more than the level between supply and demand. As soon as central banks take care of inflating demand by buying themselves financial assets, with a constant supply, stock market indices will rise.
Markets administered by central banks
Of course, that says nothing about the intrinsic “value” of the companies, or the savings. This does not say more about the future of demand (central banks may one day stop buying), nor of the future of supply (all equity holders may one day panic in concert given the difference between their judgment on value and their observation of the price, and overwhelm the purchasing capacities of central banks with their sales).
But for more than ten years, any somewhat attentive observer will have noticed that the level of the equity markets is indeed literally administered by the central banks.
What about the influence of politics on the markets?
In the short term, it has to be said that politics matter little more than the economy. The past few weeks have seen the United States struggling with an outbreak of civil violence and renewed geopolitical tensions with China. But these tremors have clearly left the stock markets in the United States, rising continuously. If central banks can annihilate the effects of the real economy on the stock market, why shouldn’t they do the same with those of politics?
However, it is different in the medium term. The reason is that the real economy and the intervention of central banks is joined by a third factor that makes other operators: confidence.
This dimension, overused, is decisive for the financial markets over time. A political leader like a central banker derives his ability to act from the credibility of his objectives, that is to say from the confidence of all that his actions will have the expected effects.
Thus, the recovery plan proposed by the European Commission has not yet been approved by European or national parliaments, and will in any case only come into action from 2021, in a very gradual manner, and will not in total represent more than 3% of gross domestic product (GDP).
Therefore, for the time being, the salvation of the euro area continues to rest mainly on the European Central Bank (ECB). But still. The markets welcomed this plan, even before the ECB strengthened its support, because it is a powerful lever of confidence in the medium-term stability of the European Union.
The political intention of Germany, as expressed alongside that of France and included in the European proposal, is being awarded a substantial price by the markets for the renewed confidence it inspires.
In the United States, President Trump has chosen, in the face of the multiplication of protests in the country, to support the primacy of “law and order” which he thinks, perhaps indeed rightly, be the preference of a majority of Americans. But the medium-term challenge lies elsewhere: it is in the degree of mobilization of the African-American electorate in the next presidential election in November.
If the events of the past few weeks produce a mobilization of this electorate in the Midwest states, decisive for the outcome of the election, comparable to that which Barack Obama had benefited from twice, then investors will not fail to adjust their portfolios by forecast of a future economic, fiscal and regulatory environment significantly different from what it is today.
Another example: in China, the considerable deterioration in the employment situation does not seem to worry the authorities to the point of announcing a vigorous economic recovery plan. The markets are content with it.
The problem is that the risk of social instability seems to be more addressed by an appeal to national pride. This is in any case what is tempting to read in the very virulent position adopted with regard to Hong Kong, in the resurgence of tensions with India in Ladakh, and across the India-Pakistan economic corridor, or in face to face with Malaysia and Vietnam in the China Sea. This choice of geopolitical tension rather than economic support could become an obstacle for confidence in the medium term.
In conclusion, therefore, policy matters to investors. Because while the short-term volatility it sometimes causes can often be overlooked, it would be wrong to underestimate it as a potential source of major inflections over time.