22nd June 2020
A new normal
After a wobble, capital markets have stabilised again. Global stock markets have not quite regained their
previous highs, but seem to have found a level, trading sideways since last Tuesday. For onlookers though,
risk asset prices probably look anything but stable. Economic activity is plummeting around the world,
deep-seated social problems are rearing their heads and geopolitical tensions are flaring up every day. But
in the midst of the chaos, equity markets have soared. Stock valuations – in terms of price over earnings –
are now at their highest since the dot-com bubble 20 years ago. How can markets be so stable when they
seem to be on a tightrope?
More life support for Britain’s economy
After three months of shutdown, Britain is slowly but surely opening up. The government has been keen
to stress that this process is only possible because of the steadily falling infection and death rates across
the country, but clearly the relaxing of restrictions is also prompted by economic concerns. With pubs,
clubs, shops and many other businesses shuttered since the end of March, the UK economy has been on
life support. For many businesses, the government’s furlough scheme and emergency loan measures have
been the only thing keeping them afloat. These policies have only been possible through the extraordinary
fiscal and monetary stimulus measures from Whitehall and the Bank of England (BoE) respectively.
CLO chills for bond markets
Avid followers of the global financial media got a bit of a fright recently. Writing in The Atlantic, Professor
Frank Partnoy of the University of California asked readers to consider a nightmare scenario: “Imagine if,
in addition to all the uncertainty surrounding the pandemic, you woke up one morning to find the financial
sector had collapsed”. Like Kafka’s Metamorphosis, Professor Partnoy takes us through what it might be like
to wake up to such a terrifying situation.
He makes some very good points. But of course, his article “The Looming Bank Collapse” doesn’t just
encourage us to imagine that fateful morning, it asks us to believe it is really around the corner. According
to Partnoy, the reason financial collapse could be imminent is because bank balance sheets in the US and
around the world are bloated with risky financial instruments: Collateralised Loan Obligations (CLOs).