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Photo: Bloomberg
Photo: Bloomberg

Equities rally on optimism even as economies slump

Global equity markets are registering strong performance even as the world economy is expected to contract. For the first time, all economic regions are set to witness contraction due to covid. Mint explains the reasons for the divergence between markets and markets and real economic activity.

Global equity markets are registering strong performance even as the world economy is expected to contract. For the first time, all economic regions are set to witness contraction due to covid. Mint explains the reasons for the  divergence  between  markets  and  real  economic  activity.

What’s behind the rally of equities in markets?

Equity markets have recovered from the record lows that were experienced during the early days of the coronavirus pandemic in March and April. This recovery has come with the fact that countries across the globe have started to announce stimulus packages to assist economic recovery while simultaneously lifting restrictions on lockdown to make room for economic activities to take place. The record low levels of interest rates and surplus liquidity have also contributed to higher investments in equity as an asset class as investors search for a higher return on their investments.

What about covid-led economic contraction?

The contraction across globe is due to the extent of disruption of economic activity that has taken place during the first half of the current year. With several countries enforcing curbs and implementing social distancing measures, supply chains got disrupted, and economic activity came to a halt. This has pushed several companies to file for bankruptcy even as governments announce measures to contain the economic fallout of the pandemic. The extent of uncertainty has resulted in many firms opting to shut shop than continue operations even as lockdown restrictions are being lifted.

Slow recovery
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Slow recovery

Don’t higher bankruptcies negatively affect markets?

Higher bankruptcies conventionally result in risk aversion on part of the investors. Difficulty in firms’ selection under a highly uncertain period combined with a higher preference for safe assets would hit markets. However, a bulk of this effect was felt in the early days of lockdown(s) when global equities witnessed record declines. Since then, the level of uncertainty has reduced.

Are markets being too hopeful about  revival?

Markets are being driven by the surplus liquidity in international markets, positive outlook owing to policy support by governments, and by discounting future income streams rather than focusing on present stress on balance sheets. Positive outlook on a likely vaccine and promising results of different medicines for treating covid-19 patients have also resulted in an optimistic outlook. The prospects of a V-shaped recovery following rapid normalization of economic activity have further caused an optimistic outlook.

What does  it  have  to  do with  vaccine  prospects?

The economic slump and crash of markets were caused by covid-led uncertainty. Many have argued that addressing the health emergency is critical to reducing uncertainty which will positively affect activity and assist in a swifter recovery. This makes it important for the vaccine to be developed to prevent a second wave and reduce uncertainty around future policy interventions such as curbs on social gatherings. Positive developments on vaccines will likely uplift the sentiment.

Karan Bhasin is a New Delhi-based policy researcher.

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