While central banks have looked to stimulate economic growth by lowering interest rates to encourage investing and borrowing, the growth objective has not been met
In response to the 2008 global financial crisis, and on the back of the Covid-19 pandemic, central banks in Western countries have been implementing quantitative easing for over a decade to try to keep inflation at target.
This unconventional stance – which involves setting record-low borrowing rates and buying corporate and government securities on a large scale – was supposed to be a short-term monetary policy to encourage lending and stimulate growth. However, after so many years, it appears that this has now become the norm.
To understand just how drastic these measures have been, note that right before the Great Recession, the US Federal Reserve had set its Fed Funds Rate, the target rate at which commercial banks borrow and lend their excess reserves to each other, at around 5.25 percent and it is now next to zero.
The rate at which governments are buying bonds is just as dramatic. Since the start of the pandemic, the Fed has bought $80 billion in treasury bonds and $40bn in mortgage bonds each month. Within this context, savings rates and bond yields have become particularly unattractive and this has pushed a vast amount of money into capital markets.
While the real benefits of indefinitely increasing the supply of money is up for debate, there is one certainty about quantitative easing: It has artificially pumped-up asset prices, and more particularly it has widened the disconnect between the valuation and intrinsic value of companies.
This policy, which has enabled Western economies to support their tremendous indebtedness and deficits, has pushed stocks to record-highs and valuation metrics to staggering levels. The Shiller P/E ratio, an inflation and cyclically adjusted price-to-earnings metric developed by Yale economist and Nobel laureate Robert Shiller, hit 39.04 in early September this year. Over the past 140 years, it has only reached this level once: During the dot-com bubble.
The valuation uplift in public markets has contaminated the private sector across the globe, including in the MENA region. Most private companies value themselves using valuation metrics of their listed competitors as reference points.
Globally, the number of new unicorns – private companies or start-ups valued at or over $1bn – has never been higher. According to Dealroom.com, the first half of 2021 saw more than two new unicorns announced each day, which is 25 percent more new unicorns than in the whole of 2020 and 33 percent more than in 2019.
Boosted by a surge in equities and higher liquidity, global venture capital funds invested $268.7bn in the first six months of 2021, far surpassing their total investments of $251.2bn for the previous year, according to data from Refinitiv.
The valuation uplift in public markets has contaminated the private sector across the globe, including in the MENA region.
If these funds are willing to invest in companies on ever-increasing valuation multiples it is because they are overfunded – a direct consequence of the billions of dollars being poured into the markets every month by central banks – and have capital deployment targets.
Small and mid-caps have not been spared from this trend either, with their valuations also rising exponentially in recent years, building up unsustainable expectations. Indeed, with a high valuation comes high expectations, which means that small and mid-caps will face a lot of pressure from investors who are eager to get their money’s worth.
A high valuation also means that small and mid-caps will find it increasingly difficult to raise capital in the subsequent phases of their development when these more-than-favourable market forces cool down.
Bottom line, while central banks have looked to stimulate economic growth by lowering interest rates to encourage investing and borrowing, the growth objective has not been met – Western economies have exhibited moderate growth.
We are now in a one-of-a-kind market bubble, with the big winners so far of this monetary largesse being the owners of financial assets.
Consequently, it is more than time to stop this monetary experiment by breaking from the low-interest cycle and dampening asset purchase plans, allowing capital markets to correct and for governments to implement strong policies to support economic growth in parallel, whether through fiscal stimulus or better budget allocation.
Guillaume Bremond, managing director at Perpetua Investment Group.
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By Guillaume Bremond
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The case against monetary largesse
While central banks have looked to stimulate economic growth by lowering interest rates to encourage investing and borrowing, the growth objective has not been met
In response to the 2008 global financial crisis, and on the back of the Covid-19 pandemic, central banks in Western countries have been implementing quantitative easing for over a decade to try to keep inflation at target.
This unconventional stance – which involves setting record-low borrowing rates and buying corporate and government securities on a large scale – was supposed to be a short-term monetary policy to encourage lending and stimulate growth. However, after so many years, it appears that this has now become the norm.
To understand just how drastic these measures have been, note that right before the Great Recession, the US Federal Reserve had set its Fed Funds Rate, the target rate at which commercial banks borrow and lend their excess reserves to each other, at around 5.25 percent and it is now next to zero.
The rate at which governments are buying bonds is just as dramatic. Since the start of the pandemic, the Fed has bought $80 billion in treasury bonds and $40bn in mortgage bonds each month. Within this context, savings rates and bond yields have become particularly unattractive and this has pushed a vast amount of money into capital markets.
While the real benefits of indefinitely increasing the supply of money is up for debate, there is one certainty about quantitative easing: It has artificially pumped-up asset prices, and more particularly it has widened the disconnect between the valuation and intrinsic value of companies.
This policy, which has enabled Western economies to support their tremendous indebtedness and deficits, has pushed stocks to record-highs and valuation metrics to staggering levels. The Shiller P/E ratio, an inflation and cyclically adjusted price-to-earnings metric developed by Yale economist and Nobel laureate Robert Shiller, hit 39.04 in early September this year. Over the past 140 years, it has only reached this level once: During the dot-com bubble.
The valuation uplift in public markets has contaminated the private sector across the globe, including in the MENA region. Most private companies value themselves using valuation metrics of their listed competitors as reference points.
Globally, the number of new unicorns – private companies or start-ups valued at or over $1bn – has never been higher. According to Dealroom.com, the first half of 2021 saw more than two new unicorns announced each day, which is 25 percent more new unicorns than in the whole of 2020 and 33 percent more than in 2019.
Boosted by a surge in equities and higher liquidity, global venture capital funds invested $268.7bn in the first six months of 2021, far surpassing their total investments of $251.2bn for the previous year, according to data from Refinitiv.
If these funds are willing to invest in companies on ever-increasing valuation multiples it is because they are overfunded – a direct consequence of the billions of dollars being poured into the markets every month by central banks – and have capital deployment targets.
Small and mid-caps have not been spared from this trend either, with their valuations also rising exponentially in recent years, building up unsustainable expectations. Indeed, with a high valuation comes high expectations, which means that small and mid-caps will face a lot of pressure from investors who are eager to get their money’s worth.
A high valuation also means that small and mid-caps will find it increasingly difficult to raise capital in the subsequent phases of their development when these more-than-favourable market forces cool down.
Bottom line, while central banks have looked to stimulate economic growth by lowering interest rates to encourage investing and borrowing, the growth objective has not been met – Western economies have exhibited moderate growth.
We are now in a one-of-a-kind market bubble, with the big winners so far of this monetary largesse being the owners of financial assets.
Consequently, it is more than time to stop this monetary experiment by breaking from the low-interest cycle and dampening asset purchase plans, allowing capital markets to correct and for governments to implement strong policies to support economic growth in parallel, whether through fiscal stimulus or better budget allocation.
Guillaume Bremond, managing director at Perpetua Investment Group.
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