“The equity market is moving towards a bubble”, said Jeroen Blokland said during the annual Fondsnieuws Investment Outlook, organised by Investment Officer Luxembourg’s Dutch sister publication. High valuations and exaggerated growth expectations make the probability of corrections in 2022 very high. This statement did not meet with unanimous approval. According to Edin Mujagic, chief economist at OHV Asset Management, this is in fact the ideal environment for equities.
“I would be surprised if we do not see a strong correction in the equity markets next year,” said Jeroen Blokland in his presentation. He is the founder of research platform True Insights. According to him, there is much evidence that the market is moving towards a bubble. “Valuations are 9 times out of 10 not the trigger for a stock dump, but investors are currently wrongly extrapolating the Covid-19 recovery growth.”
“Valuations are extremely high because the recovery has been unprecedented after the pandemic, but the economy will not continue to grow at the same pace as this year.” According to Blokland, the combination of high valuations and unjustified growth expectations make the probability of a correction this year significantly higher than in many other years.
The policy of central banks and inflation are two important reasons for such a correction, Blokland said. “There is a fairly good chance, if not a hundred per cent, that we will see a tightening of liquidity in the market. Markets are addicted to that liquidity, but central banks will probably raise interest rates. We are entering a period of monetary tightening.”
“Exceptional” performance is not exceptional
The annual performance of capital markets is rarely between the average of 5 and 10 percent. According to Blokland, very sharp falls and rises are much more common. “A prediction of a 20 percent gain, or a correction of 20 percent, may sound more daring, but it comes true much more often. All investors who have made such ‘firm’ predictions every year since 1900 have been proved right far more often.”
He also stated that the probability of social unrest is higher than average. “The reasons are Covid and rising food prices. Food prices are at their highest point in eight years, but judging by the increase in fertiliser prices, food seems to become even more expensive in the coming years. That sort of thing can influence the stock market climate,” Blokland concluded.
The ideal environment for shares
Edin Mujagic disagreed with Blokland’s analysis of the likelihood of corrections in the capital market. Reasonably high growth, inflation that is still acceptable and central banks that seem to have no reason to tighten policy are, according to him, the ideal environment for equities.
According to Mujagic, however, there is one important “but”. “For the first time in a very long time, there is no risk of deflation or recession. On the one hand, the very generous policy has to be eased, but not too fast, because then interest rates will rise and we don’t want that. That is a very thin string, and so the risk of error is enormous. Investors should take this seriously, central bankers make mistakes.”
Favorable Financing Conditions
“Central bank policy is reckless. If we assume that the expected interest rate rises will take place, I have the greatest difficulty in seeing when these real interest rates will become positive. Monetary policy was very loose, is very loose and will remain so. Assuming, again, that those interest rate hikes go ahead.” Mujagic said he considers that chance to be very small, as there is the so-called Favorable Financing Conditions (FFC) policy.
Not a single press conference goes by without FFC being mentioned these days, Mujagic argued. According to him, favourable financing conditions mean nothing more than keeping interest rates low. “There is nothing about this in the Maastricht Treaty, but it has become the ECB’s guiding principle. The ECB aims for 2 percent inflation, but if inflation rises to 4 percent, nothing happens. If the 10-year interest rate in the eurozone rises a little and the spreads between Italy and Germany widen, the ECB will intervene.”
Interest rates will remain low for years to come
Mujagic argued that the ECB wants to tackle debt with the FFC tactics. “You cannot run the risk that interest rates in the eurozone will rise, because then many families, companies and governments will get into trouble. Logically, if you raise interest rates first, you create room to lower them later. That is not happening now and so monetary easing will become the new way to control inflation. In time, the ECB will start looking not only at government and corporate bonds, but also at equity markets,” Mujagic said.
“The growth we see now is the growth of the recovery from a lousy 2020. If that recovery growth disappears and it is very likely that it will in the coming year, then you get to an environment where I wonder if it is sufficient to raise interest rates at all. If a snail has to crawl from Amsterdam to Emmen, it will arrive there before the ECB raises interest rates significantly”, concluded the monetary economist.