A Thicker Skin

The stock markets have proven surprisingly resilient since the beginning of the year. Assaulted on geopolitical, economic, and monetary fronts, they shivered for a few weeks before volatility abated.

Even this week’s sobering economic forecasts by the IMF under the dramatic title War sets back the global recovery,’ a delightful read for doom-mongers and Scream(2022) fans, failed to make an impression. Year-to-date, the US and European equity indices are down in the high-single-digit percentage territory only.

Various elements support these constructive dynamics: the robust quarterly earnings published to date; a lack of fundamental change in the monetary regime given the persistently low level of long term real interest rates; the role of equities as an inflation hedge; inflation expected to revert to its mean as the invisible hand works its magic on the supply-side of the economy; a belief in China’s macroeconomic prowess in the face of challenges (lockdowns and real estate); and faith in the EU’s ability to use its fiscal firepower to support the further acceleration of its energy transition away from a hostile supplier.

In addition, there could be a new, powerful force at play. What if society has grown a thicker skin in recent years? The imperfect, albeit broadly successful management of the health crisis has possibly strengthened the world’s ability to withstand heavy punches. Far from having shaken economic actors’ self-confidence, COVID may have instead brought it to a new peak.

Following this line of thought, market participants may believe that the world economy has acquired cat-like righting reflexes that allow it to always land on its feet. Sky-high energy prices? Government and emerging markets debt vulnerabilities uncovered by higher interest rates? A new COVID variant? A populist president in France? Growth deceleration in China? If a global pandemic can be survived, any new crisis will be handled with agility, ingenuity, and technology.

A quote from The Best Exotic Marigold Hotel’ (2011) captures that state of mind: ‘Everything will be fine in the end, and if it is not fine now, it is because it is not the end.’

Here is how psychological resilience meets corporate finance: If investors can confidently project themselves into a fine state in a foreseeable future, they can discount it back to today at a safely low rate. By doing so, they prevent equity valuations from experiencing a correction during challenging times. Such a mindset would explain why both the stock markets and M&A activity have proved resilient this year.

There is little doubt that this interpretation of market behavior will be thoroughly tested in the coming days, weeks, and months.

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