Financial markets are usually extremely efficient pricing mechanisms, which means they take on board all information that is available and rapidly change prices accordingly. This is a good thing because it means all investors have the same information and prices are fair. But it means I, and all investors, have to really think hard about what’s worth owning, and when.
A host of companies have had to shut down and its effect on underlying earnings is being matched with vast scale stimulus from both governments and central banks. There are a number of reasons why they have chosen to act like this, and in contrast to the lethargic response after the financial crisis in 2008, I would argue policy makers are making the right moves.
Generally, the economy usually works with inputs from three key areas: consumers, companies and governments. The first two are clearly in ‘lockdown,’ rapidly cutting spending in all areas and showing grave concern as to the future. In such a scenario it is up to governments to generate the demand through a range of fiscal measures such as tax cuts, income support, direct spending and infrastructure projects.
The monetary stimulus, or interest rate cuts, are largely aimed at ensuring the banking sector continues to function. This is important for both banking stocks, of course, but also the functioning of the wider economy. There is a risk of course, and this is that inflation will rise in the short term and the value of our savings and cash will decrease.
This is misplaced given the economy is no where near firing on all cylinders. Whether inflation spikes in the longer term, which it should given what central banks are doing, depends on how quickly consumers and businesses recover.
And all of this impacts banking stocks, profitability and whether they are worth buying. A topic I have been considering recently. Until we see a lifting of this fear, it is too early to invest in the banking sector, an area that needs a general level of confidence in which to invest and generate returns.