European stock watchdog warns of market correction
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European stock watchdog warns of market correction

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The European stock market watchdog ESMA considers the chance that the financial markets will be hit particularly high. “Rising valuations, price fluctuations in the crypto market and the increasing risk of major setbacks raise questions about a possible exuberance of the markets.”

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Now that European financial markets have continued their recovery in the first half of the year, they are trading at valuations around or even above pre-corona levels, ESMA says.

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Both large, institutional investors and small investors should take into account that the risks of a ‘potentially significant’ market correction have increased considerably, according to ESMA.

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Both companies and governments are accumulating debt. But the valuations of those bonds, and certainly the variant that offers higher than average interest rates, are already a lot higher than in pre-corona times, according to the ESMA.

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Greater risk appetite

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Equity investors also take a lot more risks, which can lead to greater volatility in the stock markets – think of the swings that GameStop investors can trigger. The European and American stock markets have risen by about 20 percent since the beginning of this year. The broad European stock index Stoxx600 and the S&P500 broke records in recent weeks.

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The greater appetite for risk has not only been seen in the stock markets in recent months. ESMA explicitly refers to the crypto market and to the scandals about the hedge fund Archegos and the British finance company Greensill.

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ESMA warns that both large institutional investors and retail investors should take into account that the risks of a ‘potentially significant’ market correction have increased significantly.

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The regulator does acknowledge that the economic picture has started to look better in the first six months of the year. But this has been offset by rising valuations of all asset classes, crypto price swings and the increasing risk of major downturns as trading volumes have increased. That raises questions about the increased risk behavior and possible exuberance of the markets.’

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Only when we see resilience in the current market trends for a slightly longer term will we take a more positive view of the risks.

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As if growing inflation concerns weren’t enough, governments’ loose monetary policy, doubts about the profitability of banks and insurers, and high corporate and sovereign debt also make it difficult to estimate how the economy will evolve in the medium term, according to ESMA. .

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ESMA believes that investors will have to live with those risks for some time to come. ‘Only when we see resilience in the current market trends for a slightly longer term, will we assess the risks more positively.’

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‘Heavy correction is difficult’

‘What happens in the markets makes sense. It is the result of the policy of the central banks. They make cash and bonds unattractive,” said Philippe Gijsels, chief strategist at BNP Paribas Fortis. ‘Whoever has cash loses money because interest rates are zero and inflation in Europe has risen to 3 percent. Bonds are extremely expensive. The result is that the rest – real assets such as shares and real estate – rises.’

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What happens in the markets makes sense because it is the result of central bank policies.

Philippe Gijsels

Chief Strategist BNP Paribas Fortis

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Gijsels notes that awareness of the persistently low interest rates is becoming more and more common. “The reaction of investors is logical. Their decisions are not speculative.’

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“It is difficult in the current circumstances to have a severe correction in the stock markets,” underlines the market strategist. ‘At a small correction of 1 or 2 percent, buyers immediately appear. I would like to see a correction of 5 percent or a little more. That would provide better buying opportunities.’

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ESMA is not the first institution to think that investors are too optimistic. The European Central Bank signaled in May that it is concerned about the ‘exuberance’ in some markets. The International Monetary Fund has repeatedly warned that stocks and corporate bonds are expensive.

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