Is a second stock market correction coming?

A "more severe" stock market correction is coming, according to the boss of Allianz.

Oliver Bate, interviewed on Saturday at the China Development Forum in Beijing, predicted a rout on equity markets was overdue.

He told CNBC that markets had been “really been buoyant for a long time now” and that “valuations are extremely high, higher than you can actually justify based on fundamentals”.

Mr Bate couldn’t give a precise timing for the correction, but he - and the Munich- based financial services giant Allianz - are convinced one is coming and that market risk is "severely mispriced". As a result Allianz is being "very, very careful".

This might be an overly pessimistic view, considering the the global economy seems to be in a pretty good place and given the correction markets have already seen since the start of February.

But the global stock market rally has been running for a long time. In fact it’s been running for nine years, fuelled in part by quantitative easing (QE) and low interest rates.

For those who fear the rally was always fed by QE and low interest rates and little else - and Mr Bate may well be among them - we are reaching a dangerous moment.

Inflated markets

But his argument that equities are, and have been, overpriced for some time is as old as Methuselah. The extent to which anyone gives it any credence these days is debatable.

It is the speed at which markets accelerate that really causes fear today. Hence why few trusted the mini-boom in equities around Christmas and New Year that saw the Dow Jones soar by 2,000 points.

Ultimately, anyone who invests for the long term will enjoy a healthy return on their stocks, which is why the regular advice to investors is not to panic when there is a downturn or correction.

If you bought shares in the wake of the financial crisis you will have seen an incredibly healthy return on your investments. But all rallies run out of steam. That the rally will eventually come to an end is just common sense. How it does so, and whether the global markets return to earth gently - or come crashing down - is what worries investors.

One of the causes of high equity prices has been the new trend for share buybacks. In recent years huge international corporate entities awash with cash and with nowhere to put it bought shares back from investors at inflated prices.

From the point of view of investors this was manna from heaven: a huge return on your investment, while the massive corporation gains greater control of its company, boosts its share price and floods the stock market with cash, which investors use to buy new shares.

New normal

On and on the cycle goes, until the money eventually runs out - which hasn’t really been possible thanks to QE - or investors turn their attention elsewhere as market conditions change.

Now interest rates are beginning to rise and QE is being brought to an end in the US and Europe.

Throw in a bit of profit-taking, the increasing availability of, and competition within, the bond market - and the prospect of a trade war between the US and China - and suddenly bonds look a lot more attractive to investors, while equities start to look decidedly less secure than they did three months ago. Volatility in stock markets won’t encourage investors either.

That doesn’t mean we’re headed for a stock market crash though. Ten years on from the financial crisis, monetary policy has begun the long road back to normality. Given central banks will want to avoid another crisis at all costs, it may take another decade before it gets there. So there’s no need to panic.

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