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Should we fear a major stock market correction?

Financial Crisis

Soaring oil prices, explosion of gas and electricity prices, sharp inflation rise in Europe, disappointing job creation in the United States, worrying government debt levels…

Despite an agreement reached across the Atlantic at the end of last week to raise the debt ceiling until December , and thus avoid a default by the world’s largest economy, the news is hardly reassuring for investors.

The spectrum to an energy crisis to come, with difficult to predict economic and social consequences, accentuates the nervousness of financial operators a little more every day. Especially since it represents a serious threat on the current economic recovery, currently real, but still and always conditioned to the unpredictable evolution of the health situation.

Should we fear a major stock market correction in the coming weeks?

Obviously, it is impossible to give a precise answer to this question. But last Friday the Bank of England (BOE) did not rule out this dark scenario. In many markets, the value of assets seems high compared to their historical level, underlined the BOE in its quarterly report on financial stability, and "could drop sharply if, for example, investors revise their forecasts of growth, inflation and interest rates ”.
The BOE thus warns that there are "signs of loosening lending standards, heightened risks at some investment banks." Which "could affect UK financial stability, directly through the banks and indirectly with losses spilling over to other parts of the economy."
The Bank of England reminds us: risky markets have been supported by the flow of liquidity released by central banks around the world, which is supporting economies recovering from the shock of Covid-19. "With the economic recovery and the end of government support, business bankruptcies are expected to increase (and leave) their currently historically low level," the BOE further warns.

A paradoxical situation

In short, there are many uncertainties and the horizon is tight ... The overvaluation of the stock markets is in large part due to accommodative monetary policy and the injection of massive liquidity into the economy by central banks. They know this very well and it is therefore quite paradoxical to see them today drawing attention to the risks of correction. These central banks are now, in reality, held hostage by their own policies. It's like a pyromaniac calling attention to the dangers of ... fire. This situation leaves one in doubt.

But then what about the risk of correction?

Econopolis doesn't really believe we should fear a large-scale crash this fall, or even this winter. As long as the central banks continue this accommodative policy - which could be the case for several more quarters, even several years - the corrections will be only very limited, in time and in their magnitude. 
Look at what happened in September: the markets fell 3%, which sounds like a lot but actually doesn't mean much in the long run. Every small correction will encourage central banks to continue in the same direction. So a big market correction doesn't seem possible to us, at least not as long as there is such an injection of liquidity into the global economy.  The evidence is a current lag between the development of inflation that is gaining ground - consumer prices soared by 3.4% in September and stable interest rates on an annual basis in the euro zone , with central banks buying government bonds on a massive scale. A totally different situation from the 90s and out of step with ... economic logic.

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