Overconfidence on the financial markets?


On the 8th of June, De Nederlandsche Bank (the Dutch central bank) released their prognosis for 2020 in which they expect the Dutch annual Gross Domestic Product to shrink by 6.4 percent. This scenario assumes that the corona virus will be contained for the second half of the year and that a vaccine will become available in 2021. Despite the optimistic assumptions beneath this prediction, it is already more depressing than the prognosis released by the Central Plan Bureau (CPB) in April. Around the time the report of the DNB became public, the AEX stock index was flirting with 570 points, which is only 10 percent below its previous peak in the middle of February. The Nasdaq composite index already surpassed its previous high in the beginning of this year.

There seems to exist an increasing divergence between expectations of financial market and the outcomes of macroeconomic models. Where macroeconomic predictions are becoming increasingly pessimistic over time, stock prices reflecting investor’s confidence converge back to their record levels. In addition to high levels of confidence, stock prices could be driven up by (foreseen) benefits of the fiscal stimulus packages induced by governments around the world. Including all fiscal stimulus packages, these could globally add up to 12.000 billion US dollars of government money.

Also, central banks expand their purchasing programmes of corporate bonds and government bonds. These programmes result in bottom-level or even negative rates, these rates then get passed on by banks and other financial institutions to their customers.

Where these programmes provide cheap credit to firms and government, reducing the risk of default or a bail-out, they simultaneously decrease the already low yields for investors in bonds and other forms of credit.

This phenomenon drives investors further into alternative investment products such as the stock market and real-estate. This is also the reason why the DNB does not foresee house prices to drop substantially due to the recession induced by the coronavirus.

Besides, these effects drive investors into the stock markets, investor confidence also remains relatively untouched. While (Dutch) consumer and producer confidence both reached an all-time low since their measurements started in 1986, investor confidence is only at a four-year low.

Also, as the probability of a second wave is very realistic, the first wave is not even fully behind us. Where in the West, statistics illustrate that the spread of the virus is slowly being extinguished, the pandemic is still in an ascending phase in other regions of the world such as South-America and India. As the economic consequences, induced by this pandemic, are unlike any before in recent history, its course is more prone to speculation than modelled outcomes. However the financial market seems to have chosen its position in the matter, an optimistic one.

By: Joris Hoefnagel