With almost all indices worldwide at record highs and US stock markets doubling in value after the March 2020 low following the Covid-19 crisis, the risk of a correction is increasing, according to European Securities and Markets Authority (ESMA), the European stock market watchdog, in a statement released yesterday.
In its most recent report, the regulator states that “the continued rise in valuations of all asset classes in a context of European recovery and low interest rates has increased the risk of a correction.”
For example, ESMA points to risky positions taken in popular meme stocks such as GameStop, Archegos and Greensill.
ESMA continues to point to high risks and shaky underlying fundamentals. The outlook is for risks to remain high and the sustainability of private and public debt is also a concern. On top of this, there are high inflation expectations.
According to ESMA, current market trends need to “demonstrate resilience over time before the risk assessment can become more positive”. The extent to which these risks materialise will depend mainly on market expectations of a continuation of the particularly accommodative monetary and fiscal policies, as well as the pace of economic recovery and inflation expectations.
Investors take more risk
The increased risk appetite of investors is a particular thorn in ESMA’s side. This is linked to rising valuations and the excellent performance of instruments in which retail investors especially invest.
For instance, since the Covid-19 outbreak, retail investors have become much more active in the markets. According to ESMA, this is due to a number of factors, including innovative new online and mobile trading platforms that are easy to use and do not charge commissions to trade in certain cases. However, such things can go wrong for inexperienced investors, as well as the fact that investors start cheering each other on when using social media and sometimes receive misinformation.