By Romain Boscher
As equity markets remain close to record highs, some investors are wondering whether we are at levels that can be best expressed as “irrational”. But this is taking place within the confines of rationality. Given the conditions in the market, a scenario is playing out where market participants are behaving logically to such an extent that it’s forcing unusual divergences in the value of securities. This is creating a two-speed economy of winners and losers: the ‘K-shaped’ recovery.
Irrational exuberance with a twist
Former US Federal Reserve Chairman Alan Greenspan is famed for describing booming markets during the dot-com bubble of the late 1990s as “irrational exuberance”. A generation later, this concept is back with a twist, and, as it happens, fuelled by the US central bank itself.
This is closely related to another concept associated with Greenspan - the ‘Fed Put’, which was first coined during the 1987 stock market crash but gained renewed prominence under his successor Ben Bernanke. During the Bernanke era it implied a safety net where the central bank would purchase government bonds at high prices in order to lower the Fed Funds rate.
Today, major central banks around the world are buying a whole range of assets at an almost unfathomable scale. A similar level of amplified spending can be observed on the fiscal side, where growing budget deficits have in some cases have more than offset the impact of the Covid-19 related recession. One example is the many unemployed Americans who have seen their income rise during lockdown, exceeding their previous work income.
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