The International Monetary Fund said markets have grown complacent despite lingering trade tensions, as risks to global financial stability remain elevated.
In its latest Global Financial Stability Report, released on Tuesday, the fund said asset prices had returned to stretched valuations after a volatile period in April, following US President Donald Trump's sweeping tariff announcement.
“Complacency basically refers to the observation that markets are shrugging off the broader level of uncertainty that commentators, analysts, economists … point to,” said Tobias Adrian, director of the IMF's monetary and capital markets department.
Global financial stability risks have receded only modestly since April, the fund said in its report. It warned risk asset prices are well above fundamentals and could lead to disorderly corrections in the event of adverse shocks.
Since a broad global sell-off in April, US markets have reached record highs. The S&P 500 and tech-heavy Nasdaq Composite are up about 13 per cent and 17 per cent this year, respectively, while the Dow Jones is up about 9 per cent.
European markets have rebounded similarly, with the Europe Stoxx 600 up roughly 11 per cent this year. Meanwhile, emerging markets have been outperforming US equities partly because of a weaker dollar.
IMF monetary and capital markets department
US-China trade tension flared again ahead of the IMF and World Bank annual meetings in Washington, as Mr Trump threatened to impose new tariffs on Beijing after it announced plans to impose strict export controls on rare earth minerals.
Wall Street rebounded on Monday after a sell-off on Friday, after Mr Trump softened his tone on China on Sunday. “But the magnitude was fairly contained relative to say what we saw in April,” Mr Adrian said.
He added that he was surprised by the resiliency that markets, particularly among emerging economies, have shown this year.
“Capital markets really have played a role as a shock absorber relative to all kinds of policy announcements," he said. "That's a very good development, right?”
Mr Adrian said he saw no reason for the resiliency to stop, pointing to strong global regulation of banks and non-banks. However, he said the fund remained concerned about the longer-term debt of countries, with the fund projecting total debt-to-GDP to rise to about 100 per cent of GDP over the next two years, which could place pressure on global capital markets.
AI growth
Strong performance in the US this year has largely been linked to growing investment in artificial intelligence, with hundreds of billions of dollars being poured into infrastructure and AI-related projects.
Rising valuations have led analysts to compare the AI surge to the dotcom bubble of the 1990s that burst when many internet-based companies whose investments propelled market gains failed.
Mr Adrian said that, unlike the dotcom era, the tech companies driving the AI boom are hugely profitable. “So in that sense, it's not a bubble, it is actual profits, and they feed into aggregate macro activity,” he said. “Of course, profitability going forward could disappoint, but today that has surprised to the upside. And so it's a different conservation, really.”
He added that price-earnings ratios are relatively stretched, with the fund assessing it is about 10 per cent overvalued compared to its estimated overvaluation of 20 per cent in 1999.
Mr Adrian said the direct financial stability implication of a readjustment of tech stocks would likely be limited if profitability expectations are not realised in the future, noting many investments in AI have been cash or equity funded. "There's some leverage, but it's fairly contained,” he said.
However, there could be larger implications for the macroeconomic picture. One JP Morgan analysis suggests AI-related capital expenditures contributed to 1.1 per cent to GDP growth in the US the first half of this year, outpacing the consumer as the driver behind economic growth.
“Real investment in data centres and other technology-related investments, at this point, make up the entire investment of the US economy,” Mr Adrian said. "So there's a pronounced sectoral shift in terms of investment behaviour. And so how that unfolds, I think, will be important to watch.”
