Wall Street’s Surge and its Global Ripple Effect
Financial markets are experiencing a remarkable period of growth this year, with significant benefits extending to investors through their superannuation funds. The S&P 500 index has reached unprecedented highs, surpassing 7,600 points – a stark contrast to its figures of 2,100 a decade ago and 4,200 five years prior. Australia’s own share market has also seen an impressive ascent, despite some recent fluctuations.
This sustained market performance has led some academics to propose that global stock markets have entered a phase of “bliss,” characterized by an unending stream of gains. This “bliss trade” theory suggests that governments and central banks are highly reluctant to allow major corporations to fail due to the potential financial instability such collapses could introduce into the monetary system. Historical precedents, such as the 1929 stock market crash leading to the Great Depression and the 1987 crash’s contribution to the 1992 Australian recession, underscore the severe economic consequences of market downturns.
The Concept of Moral Hazard in Investing
A fundamental principle in investing dictates that higher risk should yield greater rewards. However, this concept was challenged during the global financial crisis when several prominent Wall Street investment banks received government bailouts. While Lehman Brothers was allowed to collapse, the subsequent interventions fostered the notion that some financial institutions were simply “too big to fail.”
This situation created a moral hazard for corporate executives, potentially encouraging them to undertake significant risks with the assurance of government rescue in the event of substantial losses. Gemma Dale, director of nabtrade, notes that this investment hubris has been a recurring theme for decades. She recalls the “Greenspan put,” a period of confidence that monetary policy would always step in to cushion any meaningful downside volatility. Dale highlights the “simply astonishing” level of fiscal support provided to the economy during and after the global financial crisis.
Current analysis suggests that governments and central banks, through measures like quantitative easing, are once again poised to support large companies facing financial distress. Dale expresses concern that this situation potentially undermines the concept of moral hazard, stating, “I think that is problematic to the extent that you’ve almost removed [the idea of] moral hazard. And that’s an issue.” She believes this indicates a current lack of ethical considerations among some U.S. corporations, where once-feared immorality is now seemingly embraced.
Mega IPOs and Investor Sentiment
This seemingly risk-tolerant investment approach may have contributed to the record-breaking initial public offering of SpaceX. Despite projections of future growth, the company’s ability to achieve profitability in the near term remains uncertain, with some valuations significantly lower than its listing price. The market anticipates further blockbuster IPOs, with established tech giants like Amazon, Meta, Alphabet, and Nvidia continuing their exponential growth.
“These are very highly profitable companies, but they are ploughing all of their cash into the next big thing,” Dale observed. “And the question is whether or not they can make it work.” For investors, the success of these ventures often appears secondary. This week, for instance, billions of dollars flowed into semiconductor stocks, spurred by a significant swing in market sentiment, even amidst concerns about geopolitical stability and rising interest rates.
Michael McCarthy of Moomoo Australia noted, “A huge swing in semiconductor sentiment lifted U.S. markets in overnight trading. The rally was based on the flimsiest of news flow and narrowly focused on chip hardware manufacturers.” This suggests that the perceived safety net provided by government support for the stock market can lead to rapid capital inflows based on even minor news developments.
The Trillion-Dollar Question: A One-Way Bet?
These dynamics raise a critical question: have share markets become a guaranteed path to profits? More importantly, given the ongoing support for major companies, can the risk of a substantial stock market crash, a decline of 40-50 percent, be definitively ruled out? The last time the U.S. stock market experienced such a significant drop was during the global financial crisis.
According to insights from American billionaire investor Ray Dalio, there are concerns about the U.S.’s fiscal capacity to manage future crises. Dale relays this sentiment, stating, “If you listen to [American billionaire investor and founder of Bridgewater Associates] Ray Dalio, he is telling you that, effectively, the U.S. is broke and things are going to go very badly wrong at some point. It is inevitable. The timing is very hard to pick.”
This perspective suggests that the U.S. government may lack the financial resources to bail out major Wall Street institutions if they encounter severe difficulties. Recent trends in the U.S. bond market, including the U.S. 10-year Treasury bond yield approaching levels considered alarming, have served as a warning sign. Such rising yields can significantly impact stock valuations.
Furthermore, the moral hazard driving substantial stock market gains is leading many firms to be included in major indexes, subsequently attracting investment from index-following funds. This creates a self-reinforcing cycle. Conversely, Dale cautions that if an economic shock were to remove several large companies from these indexes, it could trigger a severe market downturn. “If people start to withdraw at some point, then you get the alternative spiral,” she warned. “It goes the other way, so this idea that we can never see a meaningful downturn, I think, is risky. But we’ve all been wrong about that for quite a while.” Many superannuation balances are currently reflecting the benefits of this prolonged market upswing.”
