Train yourself — the stock market is irrationally booming again.

opinion

by desmond ruckman

Sir Isaac Newton famously looked back at the stock market and said that while the movements of celestial bodies can be calculated, “human madness” cannot.

I can’t help but wonder what he would say about the U.S. stock market today.

Despite the major economic and geopolitical risks to the economic recovery being clear, markets continued to hit record highs like there was no tomorrow.

On Monday, the Dow Jones Industrial Average closed above 38,000 for the first time, and the S&P 500 also hit a record close.

How quickly we forget how caught the market by surprise when the U.S. subprime mortgage and housing bubble burst in 2008.

These events caused the largest market decline since the stock market crash of 1929.

The major economic risks we currently face are the result of the Federal Reserve’s hawkish monetary policy stance and the impact of the COVID-19 pandemic on jobs and shopping habits.

Starting in June 2022, the Federal Reserve has implemented the most aggressive rate hike cycle since the war.

We raised interest rates by 5 1/4 percentage points in a short period of 15 months.

At the same time, it reduced the size of its balance sheet by more than $1 trillion through quantitative tightening.

This caused significant damage to banks’ balance sheets by causing interest rates to rise sharply and reducing the value of their bond portfolios.

Thanks to the Fed’s actions, banks are facing an estimated mark-to-market loss of more than $600 billion.

Rising interest rates have also increased default rates on auto loans, mortgages, and credit card debt.

The coronavirus pandemic has significantly disrupted the $20 trillion commercial real estate market.

Employers have realized that they no longer need to have their employees come into the office every day.

As a result, office vacancy rates have risen to an all-time high of nearly 20%.

It is estimated that New York alone has as much vacant office space as 30 Empire State Buildings.

The retail space is also under tremendous pressure as the trend towards online shopping accelerated during the pandemic.

Early last year, a local banking crisis centered on Silicon Valley Bank and First Republic Bank required Federal Reserve intervention.

High interest rates and plummeting commercial real estate prices now pose a very real risk of triggering a more sinister round of local banking crises.

Commercial real estate loans account for nearly 20% of local banks’ outstanding loans, making it difficult to see how real estate developers will be able to roll over an estimated $500 billion in loans maturing this year. , is particularly dangerous.

In an ominous sign of what’s to come, major real estate developers such as Brookfield and Blackstone are returning the keys to their lenders.

A recent paper from the National Bureau of Economic Research estimates that about 400 small and medium-sized banks could fail due to high interest rates and an expected wave of commercial real estate loan defaults.

If that happens, the most important small business sector, which accounts for nearly half of the U.S. economy, will be starved for credit.

As if these economic risks weren’t enough to worry about, we now face geopolitical risks of a magnitude not seen in decades.

The war between Russia and Ukraine is the largest European ground conflict since 1945.

The war between Israel and Hamas risks spreading to other parts of the Middle East.

The Houthis have threatened to block the vital Red Sea passage to the Suez Canal.

China has expressed displeasure over Taiwan’s recent presidential election.

This has exacerbated already strained U.S.-China relations and increased the risk of escalating tensions in the South China Sea.

However, despite all these major economic and geopolitical crises, the stock market is still depressed.

It has reached a new all-time high and is trading at an overvalued valuation.

We wonder if this is a repeat of the stock market rally on the eve of World War I, but when war broke out the market had to be shut down for several months to prevent complete panic. I need to think.

Or perhaps it’s a repeat of what happened until the collapse of Lehman Brothers in September 2008, when the market was blissfully unaware of the impact of the bursting of the subprime and housing bubbles.

Either way, it’s sure to leave Isaac Newton scratching his head.

Desmond, Senior Research Fellow, American Enterprise Institute Mr. Lachman was Deputy Director of Policy Development and Review at the International Monetary Fund and Chief Emerging Economies Strategist at Salomon Smith Barney & Co..