Equity markets gained over the first part of the month only for virus concerns to re-emerge. Slower than anticipated vaccine rollouts and unease over new mutations of the virus led to a pull-back. Markets were rattled further by aggressive retail-led short squeezes in a number of heavily shorted US stocks which raised fears over the viability of a small number of hedge funds.
This ‘gammafication’ of markets is unhealthy, impedes price discovery, and highlights the misallocation of capital created by QE. It should be noted that this does not pose a systematic risk and will not be the catalyst for a material correction. High absolute valuations in certain market segments, however, may lead to volatility.
Despite stretched valuations we remain fundamentally constructive on the outlook. Outside the risk of a vaccine-evading mutation, the biggest risk to markets is the premature tightening of policy. In this regard policymakers have generally been at pains to emphasise that they are prepared to let the economy run ‘hot’ rather than risk choking off the recovery. Such a policy is eminently sensible when long-term interest rates are exceptionally low and the global economy is characterised by large output gaps. President Biden’s proposed $1.9 trillion stimulus plan – equivalent to 9% of GDP – epitomises this thinking. Fiscal stimulus is less explicit in the UK, but the Chancellor has indicated his desire to make any fiscal tightening back-end loaded. In Europe, however, the debate appears less clear-cut. German fiscal conservatives pushed back on suggestions by Helge Braun, a close aide of Angela Merkel, that the ‘debt brake’ enshrined in the constitution be formally suspended for longer than is currently envisaged.