COVID-19 Asset Pricing Bubble

By Sharada Pisupati

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With the world gripped by the COVID-19 pandemic in March 2020, the actions, reactions and the steps taken by each and every local body/ provincial governments, federal governments and their respective central banks were initially dictated by the issues faced at local level rather than at a global level. The world predicted a recession, however a recession under such circumstances was unprecedented for most policy makers, mainly due to the fact that apart from a chosen few like the essential goods industry, most of the industries saw a destruction in demand. With no previous precedence, the policy makers did not have the luxury of history and were faced with unprecedented situations and acted accordingly. The repercussions of such actions will be only felt with time. What did the governments do?

Let’s take a deep dive into what the UK and the US governments and central banks did. The UK has, amongst other things, given a £330 billion loan guarantee to companies of varying sizes, which will provide an immediate and temporary boost to the credit pipeline. However, the government could be left in dire straits if the guaranteed party are not able to repay over a period of time. The US Federal Reserve, on its part, has pumped in $2.3 trillion into the economy and bought bonds, loans and other assets. They also asked large banks to ‘preserve capital’ by suspending share repurchases, capping dividend payments, and limiting dividends based on recent income.

Liquidity and low interest rates in the absence of complete economic activities have limited impact but the consequences of such a step can be huge if the putative economic activity shall not rise the way it is envisaged. Availability of easy liquidity is driving up asset prices to levels which are not matched with underlying fundamentals. For example, the equity prices since the lows of March 2020 in the US have seen a vertical rise which is only matched unfortunately by a rise in positive cases. This dichotomy has to have ramifications. This might take the form of an asset bubble driven by liquidity and low interest rates. Can the asset prices sustain? Will it be a bubble? Or will the latent demand push up economic activities whereby these asset prices are justified, and the prices will not witness a vertical fall? Only time will tell.

However, one thing is certain; asset prices have to correct the economic reality. What are the implications in the post COVID-19 world due to the liquidity and the pump priming measures introduced by various central banks? After all money comes at a cost.

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Key Takeaways

· Governments and Central Banks pumped in large quantities of money into their respective economies

· This has boosted asset prices to a level which is not matched by the underlying fundamentals

· Could result in a pricing bubble which could soon collapse, exacerbating the economic downturn