market disconnection runs the risk of a correction

The International Monetary Fund warned that the continued disconnect between financial markets and the real economy could lead to a correction in asset prices.

Stock markets have rebounded in recent months despite troubling real-world events. The world is grappling with the coronavirus health emergency that has claimed the lives of nearly 500,000 people, according to data from John Hopkins University, and threatens to cause an unprecedented economic crisis. Furthermore, there is social unrest in many advanced economies, as citizens demand a more egalitarian society, which could affect investor confidence.

Recent data indicates a deeper-than-expected slowdown, the Fund added, but the markets appear unflappable: the S&P 500 enjoyed its biggest 50-day rally in history in early June.

“This disconnect between the markets and the real economy increases the risk of another correction in risky asset prices if investor risk appetite fades, posing a threat to recovery,” the IMF said on Thursday. in its updated Global Financial Stability report.

A correction is defined as a decrease of 10% or more in the price of an asset or index.

The Fund said valuations currently appeared to spread across many different markets.

“According to IMF staff models, the difference between market prices and fundamental valuations is close to all-time highs in most major advanced economy equity and bond markets, although the opposite is true for stocks in some emerging market economies, “he said.

Triggers for a change in market sentiment could include a second wave of coronavirus infections, more social unrest, changes in monetary policy and a resurgence of trade tensions, the Fund added.

Asset and fund managers

There is a risk that “non-bank” financial companies such as asset and fund managersYou could also face shocks in the event of a large wave of insolvencies. The IMF warned that these companies could even act as an amplifier of this stress.

“For example, a substantial shock to asset prices could lead to more investment fund outflows, which in turn could lead to sales by those fund managers that would exacerbate market pressures,” the Fund said.

The IMF estimated earlier this week that the world economy would contract 4.9% this year, before growing at a rate of 5.4% in 2021. Both estimates were downgraded from the April forecast.

“There is tremendous uncertainty,” Gita Gopinath, chief economist at the IMF, told CNBC’s Squawk on the Street on Wednesday.

He added that “it will be necessary to continue with substantial support,” but its shape will depend on how the recovery goes.

Governments and central banks around the world have launched large stimulus programs in an effort to keep economies afloat. In the euro zone, for example, the European Central Bank is buying government bonds as part of a € 1.35 trillion ($ 1.5 billion) emergency program to keep borrowing costs down for euro zone governments. In the meantime,

The IMF also warned that corporate debt had increased for several years and is currently at a “historically high level relative to GDP (gross domestic product).” This, along with household debt, which has also grown in recent years, is another vulnerability in the financial sector and could have a broader impact on the ongoing economic crisis.

“High levels of debt may become unmanageable for some borrowers, and losses resulting from insolvencies could test banks’ resilience in some countries,” said the IMF.

Correction: The title and text of this article have been updated to more accurately reflect the IMF’s stock market prediction.