Investing Advice: IMF Has a Warning For You

Posted On April 30, 2018 11:37 am

The U.S. stock market appears to have passed through recent volatility with relatively little damage. If the current rebound holds, February and March will prove to have been a garden variety 10% correction. Today’s investing advice should remind you to be cautious, however.

This recent article from Bloomberg discusses how assets beyond equities, from commodities to cryptocurrencies, and certain government policies are creating a heightened risk for a financial crisis.

Here it is.

Threats to the global financial system are rising, with the price of risky assets surging in a manner reminiscent of the years before the global financial crisis, the International Monetary Fund warned.

Downside risks to world financial stability have increased “somewhat” over the past six months, the IMF said Wednesday in the latest edition of its Global Financial Stability Report. “Financial vulnerabilities, which have accumulated during years of extremely low rates and volatility, could make the road ahead bumpy and could put growth at risk,” said the Washington-based fund.

Investors “should not take too much comfort” in the fact there were no major disruptions from the sharp selloff that shook markets in February, the IMF said. “Valuations of risky assets are still stretched, with some late-stage credit cycle dynamics emerging, reminiscent of the pre-crisis period,” it said. “This makes markets exposed to a sharp tightening in financial conditions, which could lead to a sudden unwinding of risk premiums and a repricing of risky assets.”

Prices are frothy across a variety of assets, according to the IMF. Stock prices are high relative to fundamentals around the world, especially in the U.S., the fund said. Corporate bond valuations are also elevated, with signs of overheating in demand for leveraged loans from firms with low credit ratings, it said.

Sharp Correction

The warning comes as finance ministers and central bankers from the IMF’s 189 member countries meet in Washington for its annual spring meetings. Global stock markets suffered a sharp correction in late January and early February amid doubts about the strength of the global economy, with U.S. stocks dropping more than 10 percent.

Managing the gradual return of interest rates to normal level will be a “tricky” task that requires careful communication from central banks and policymakers to “reduce the risks from a sharp tightening of financial conditions,” Tobias Adrian, director of the IMF’s monetary and capital-markets department, said in a foreword accompanying the report.

The recent increase in trade tensions has caused “jitters” among investors, “and a wider escalation of protectionist measures could ultimately take a toll on the global economy and on global financial stability,” he said.

The IMF noted that investors aren’t currently pricing in the risk of sharply higher inflation over the next few years, leaving markets vulnerable to an “inflation surprise.”

The emergence of cryptocurrencies represents a new source of vulnerability to the financial system, Adrian said, adding that risks could arise from leveraged positions taken by investors in these assets, which only take digital form. There are also “infrastructure weaknesses” in cryptocurrency exchanges, and the risk of fraud and high volatility, he said.

While the banking sector has become more resilient since the financial crisis, it’s important for countries to follow through on the reforms they committed to after the downturn, the IMF said.

 Related: Is Recession Already Here? Here’s What You Need to Know. 

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Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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