Global equity markets may be underestimating a growing cluster of economic risks, with policymakers and investors alike warning that current valuations are out of step with reality.
Bank of England deputy governor Sarah Breeden cautioned that asset prices remain near record highs despite mounting threats.
While Emma Moriarty of CG Asset Management said markets are showing “increasingly marked cognitive dissonance” by failing to fully price in the energy shock and inflationary pressures triggered by the Iran conflict.
Together, their assessments point to a widening gap between market optimism and macroeconomic fundamentals, raising the likelihood of a correction if these risks begin to crystallise simultaneously.
Global stock markets could fall, says Sarah Breeden
Sarah Breeden, deputy governor at the Bank of England and head of financial stability, warned that global stock markets could face a decline as the current share prices fail to reflect the range of risks confronting the world economy.
“There’s a lot of risk out there and yet asset prices are at all-time highs. We expect there will be an adjustment at some point,” Breeden told the BBC, in unusually direct remarks for a central bank official.
Breeden stopped short of predicting the timing or scale of a potential market correction but highlighted the possibility of multiple risks materialising simultaneously.
She said the scenario of overlapping shocks was a key concern for policymakers monitoring financial stability.
“The thing that really keeps me awake at night is the likelihood of a number of risks crystallising at the same time,” she said, pointing to the potential for a major macroeconomic shock, a loss of confidence in private credit, and a reassessment of valuations linked to artificial intelligence.
She added that the critical question for policymakers is what happens “in that environment and are we prepared for it?”
Breeden said her role was not to forecast the timing or scale of any market downturn, but to ensure the financial system can withstand one if it occurs.
“What we are watching for: is how might those prices fall? Will there be a sharp adjustment downwards? And if there is such an adjustment, how will that affect the economy? I’m not saying it will happen today, tomorrow, in 12 months’ time. It’s ensuring that if it happens the system is resilient.”
Markets displaying ‘marked cognitive dissonance’
Investors are also increasingly questioning whether equity markets are adequately reflecting the economic fallout from the ongoing conflict involving Iran, which has disrupted global supply chains and pushed up energy prices.
Emma Moriarty, portfolio manager at CG Asset Management, said markets are displaying “increasingly marked cognitive dissonance,” as asset prices remain buoyant despite worsening macroeconomic signals.
She pointed to the closure of the Strait of Hormuz, a critical shipping route, noting that supply disruptions are now fully feeding through global markets.
Commodity and bond markets have already adjusted, she said, with oil and gas prices signalling tight supply and government bond yields reflecting higher inflation expectations.
Moriarty explained that interest rate markets have also shifted significantly.
While investors initially expected multiple rate cuts this year, pricing now reflects the possibility of rate increases instead, driven by persistent inflation.
At the same time, real economic indicators are beginning to weaken.
Rising fuel costs, warnings of potential double-digit food inflation and a decline in payrolled employment suggest that demand is starting to soften.
“By contrast, equity markets have continued their optimistic run: After a steep drawdown in the middle of March, the MSCI World Index is currently around 5% higher than it began the year – even after accounting for GBP appreciation over the period,” she said.
Resilience shows expectations that tensions will ease
Russ Mould, investment director at AJ Bell, said this resilience reflects investor expectations that geopolitical tensions will ease and energy prices will stabilise.
“The stock market reflects what investors think will happen in the future,” he said, adding that the limited pullback during the early stages of the crisis suggests confidence in a relatively swift resolution.
Mould noted that oil prices, currently around $105 per barrel, are significantly higher than earlier in the year but remain below peaks seen during previous geopolitical shocks.
Even so, he warned that current levels are already exerting pressure on businesses and consumers.
“Central banks such as the Bank of England will be watching key data points around inflation and the jobs market to see if interest rates need to change,” he said, adding that it’s a tough call as a swift resolution to the Middle East could mean that an inflation spike is only temporary, and that monetary policy may not need to go down a different path.
“But wait too long to respond and central banks could face criticism that once again they didn’t act fast enough,” he said.
“It’s unusual for a Bank of England official to explicitly warn about a potential stock market pullback, and the comment might have contributed to some of the FTSE 100’s decline on Friday.
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