As soon as the COVID-19 pandemic started to recede, as soon as rumors of a diplomatic settlement of the war in Ukraine emerged, equity markets rallied. Analysts at Natixis seek to determine why equity investors react so positively to good news, even if it is only of small significance.

Why do equity markets react so strongly to good news?

“Real interest rates are very negative, in an environment of high inflation. This makes holding cash or bonds very detrimental, and therefore encourages investors to return to equities as quickly as possible.”

“Companies’ financial situation improved rapidly after the COVID-19 crisis and was good at the start of the war in Ukraine: earnings picked up, debt net of cash holdings fell.”

“Investors do not expect a sharp rise in interest rates and expect real interest rates to remain negative, as expected long-term interest rates remain lower than inflation. Investors do not, therefore, expect that bonds will become attractive again and that rising interest rates will cause share prices to fall.”

“As long as real interest rates remain negative, holding shares protect against inflation, since negative real interest rates boost share prices and companies’ earnings normally follow inflation.”