Markets for stocks and other risky assets could suffer a second collapse if the COVID-19 spreads more widely, lockdowns are reimposed or trade tensions surge again, the International Monetary Fund (IMF) warned on June 25.
Equity markets tailspinned into bear market territory in record time earlier this year as the virus and related lockdowns pounded sentiment, but they have broadly rallied from their March 23 low.
The S&P, which fell 34% in just 23 trading days, has been boosted by central bank support and is now roughly 10% off its record high. Stocks were, however, rocked on Wednesday as infections spiked in a number of US states.
“A disconnect between financial market optimism and the evolution of the global economy has emerged,” said the IMF in its Global Financial Stability Update. The disconnect “raises the risk of another correction in risk asset prices,” the IMF said, adding that valuations across many equity and corporate bond markets appear “stretched.”
The warning came just a day after the IMF slashed its 2020 global economic forecasts further.
A correction could be prompted by a deeper and longer recession than currently anticipated, a second wave of COVID-19, reinstated containment methods or a resurgence of trade tensions, the IMF said.
A broadening of global social unrest in response to rising economic inequality could also damage investor sentiment, the IMF said.
“Bear market rallies have occurred before, during periods of significant economic pressure, often only to unwind subsequently,” it said.
The IMF also pointed to risks from aggregate corporate debt at historically high levels relative to GDP and increased household debt.
“This means that there are now many economies with high levels of debt that are expected to face an extremely sharp economic slowdown,” the IMF said.
While banks entered the crisis with higher liquidity and capital buffers, insolvencies will test the resilience of the sector, the IMF said.