IMF warns of major ‘correction’ as bullish markets misjudge economic fallout

The International Monetary Fund (IMF) has warned of "a disconnect" between financial markets and the real economy, which could result in another major "correction" in asset prices.

As the global economy heads for the biggest slump in 100 years on foot of coronavirus, stock markets, after an initial plunge in March, have been racing ahead, buoyed by central bank support.

The white-hot streak has pushed indices to multi-year highs with some stocks rebounding by 40-50 per cent.

The S&P 500 in the US, which fell 34 per cent in just 23 trading days, is now roughly 10 per cent off its record high.

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“A disconnect between financial market optimism and the evolution of the global economy has emerged,” the IMF said in its latest Global Financial Stability update.

And this “raises the risk of another correction in risk asset prices”, the Washington-based fund warned, adding that valuations across many equity and corporate bond markets “appear stretched”.

A second wave of the virus, the reintroduction of lockdowns and/or increasing trade tensions globally could trigger another big slide in prices, it said.

The warning came a day after the IMF cut its global growth forecasts, warning that the coronavirus crisis will have an even bigger negative impact on the global economy than initially thought.

Unprecedented crisis

The fund now believes the global economy will shrink 4.9 per cent in 2020, rather than 3 per cent, describing the pandemic as an “unprecedented crisis”.

“The bullish mood among investors is predicated on strong policy support amid huge uncertainties about the extent and speed of the economic recovery,” it said in its financial stability report.

Markets appear to be expecting a quick “V-shaped” rebound in activity, it said, while noting that recent economic data and high frequency indicators point to deeper-than-expected downturn.

“This has created a divergence between the pricing of risk in financial markets and economic prospects, as investors are apparently betting on continued and unprecedented support by central banks,” it said, noting the divergence between stock indices and consumer confidence in the US.

“This disconnect between markets and the real economy raises the risk of another correction in risk asset prices should investor risk appetite fade, posing a threat to the recovery,” it said.