CAMBRIDGE – Investors in US markets over the past year have shown a remarkable ability to brush off domestic and external risks to the economy’s well-being, as well as to the functioning of the global economic, financial, and trading system. This decoupling of risk from market sentiment has been driven by three factors: faith in the “sky-is-the-limit” prospects of certain technology firms, widespread confidence in American economic exceptionalism, and enduring faith in the US Federal Reserve to support financial assets. But two of these factors have lately come under pressure, leaving the durability of any positive outlook more dependent on the third.
A number of developments over the past year would normally have led to volatility, and a downward overall trend, in stock markets. The Hamas-Israel war – and the agonizing images of the large-scale loss of innocent civilian lives and massive destruction of livelihoods and physical infrastructure – has increased the probability of a region-wide conflict that could further disrupt shipping and trade, and drive up oil prices.
Moreover, the Sino-American relationship has grown only tenser. With the United States imposing yet more restrictions on technology-related exports to China, other countries are forced to navigate an increasingly complex field of secondary sanctions. The US presidential campaign has reminded everyone that new waves of tariffs against allies and adversaries could come as soon as next year. Meanwhile, domestic and regional elections have weakened moderate center-left and center-right parties in key European countries.
Investors’ ability to look past these developments cannot simply be attributed to the old mantra that “markets are not the economy, and the economy is not the markets.” Instead, markets have been insulated by the three factors mentioned above.
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