How is it possible that the stock market could stubbornly continue to rise even after the remarkable recovery we have already witnessed over the past 12 months?
Looking at the Past for Clues
Since 2008, there have been multiple times where global markets work in a synchronized manner. The first time was just after the financial crisis in 2009 and 2010. Monetary policy was stimulative and Quantitative Easing (QE) was in its infancy. After the bear market that ended in 2016, we had a year where volatility was at a historic low. Today we are seeing similar patterns where global money supply adjusted for global industrial production is extremely high. When there is excess liquidity in the market, it is very stimulative to the equity markets.
When examining the global nature of movement of economies, is it remarkable how unified economies have been the past year. We had a global pandemic which led to a global shutdown of economies and a global recession. Now, as we have several viable vaccines, global economies are looking to be heading towards reopening. This is all combined with monetary stimulus of enormous magnitude.
Looking at the All-Country World Index (ACWI), a good benchmark of global stock markets, and compare them to global real money supply, clearly in 2009-2010 and late 2016 through 2017 were good stock markets. The chart below illustrates how generally, when there is excess liquidity, markets tend to rise.
There are multiple reasons that excess liquidity is stimulative to businesses and therefore, equity markets. The biggest reason is that debt is cheap enough that even if interest rates rise during that time, there is enough money in the economy that companies never run out of access to cash. Therefore, during these times, it is not unusual to have double-digit equity returns. When it is happening on a global basis, it adds to the momentum and strengthens the trend.
Could 2021 end up looking like 2017? There are a lot of similarities in the market, but each year and time has its own risks. Certainly, there will continue to be developments in the market and on the political landscape. It is possible that since we are in the second year of a new economic cycle and first year of a presidency, we will see some hiccups along the way. However, it is unwise to fight the Fed policy. When there is so much excess liquidity, equites have tended to outperform other asset classes.
Until the data tells a different story, it is best to have a plan for navigating on a long-term basis rather than just a short-term view. The good news it that the data is currently illustrating another positive economic backdrop for 2021. Sure, there are likely to be corrections, but it doesn’t look like things will cool off dramatically leading to a bear market, despite the remarkable past 12 months of returns. We will continue to watch for evidence of overheating, but it is not evident from data at this time.
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Trek FG 21-39