The Paris terror attacks have shown that the world is confronting more serious and new threats. On top of an uncertain global economic environment, we now have heightened geopolitical concerns. But what is remarkable is that despite all this chaos, the stock markets have stayed relatively calm.
Maybe the market has learnt that event risks will have just short-term impact on asset values. In the past 20 years, we have emerged from many crises, including the Asian financial crisis, the dot-com bust, the 9-11 attacks, SARS and the 2008 global financial crisis.
Every time we had a crisis, government and central banks tried their best to shield the markets and reduce volatility.
After the 2008 crisis, the Fed and other major central banks seemingly reached a consensus to use monetary policy tools to boost the economy. The model has created a safety net for financial markets.
Stock markets around the world dipped on Monday after the Paris tragedy but rebounded quickly the following day. The STOXX Europe 600 Index rose 2.5 percent on Tuesday.
Many governments, including those of France and Russia, responded in a timely manner and with good strength. That has helped the markets regain their footing.
Past experience shows that the more downward pressure there is in the market, the more active will the central banks be. The European Central Bank had earlier planned to expand its quantitative easing policies in December. It might now act faster.
When yields of government bonds fall in European countries, the stock markets will rise. It will become a short term “normal”. It is noteworthy that more money goes to stock markets than the bond markets.
Risk-averse capital usually favors zero-risk government bonds. But a Bank of America Merrill Lynch survey of fund managers has shown that institutional investors are adding to their equity allocations.
Why is this happening?
Well, there are two simple reasons: 1) liquidity and 2) a desire to hedge risks due to the US Federal Reserve’s expected interest rate hike.
If the Fed begins raising rates, bond investors may find it hard to exit while stocks can benefit from improved confidence about an economic recovery.
This article appeared in the Hong Kong Economic Journal on Nov. 19.
Translation by Myssie You
– Contact us at [email protected]