In the past few months, we have seen that despite the significant decrease in economic surprise indexes, US equities have constantly been reaching new all-time highs, with the SP500 index breaking above the 4,500 level this week. We previously saw that the US mega-cap growth stocks (i.e. FANGs) have been mainly driven by the dramatic surge in global liquidity, which we compute as the total assets of the major G10 central banks.
As the FANGs stocks represent a significant share of the SP500 index (over 25%), the strong momentum in tech stocks have pushed the whole index to new highs.
Interestingly, the chart below also shows the strong relationship between the Fed’s balance sheet assets and the SP500 in the past year. As a reminder, when the Fed halted its POMO operations in the end of October 2014 (following nearly a year of tapering), US equities remained flat for 18 months and experienced several drawdowns before starting to edge higher in H2 2016 with markets starting to price in further stimulus (Tax reform plan, higher spending). See the article entitled ‘Could we survive without QE?’ that we wrote in September 2014 for more details.
Even though this time is different, there is still a lot of uncertainty over the economic recovery, therefore normalizing policy too early could halt the momentum in US equities in 2022. This is a challenging time for US policymakers as inflationary pressures remain elevated in both DM and EM economies and the Fed needs to normalize its policy in order to leave more room for a potential new economic shock in the future.
As we previously saw, the massive liquidity injection from major central banks to prevent the economies from falling into a global deflationary depression has generated a significant rebound in equities prices, especially for the mega-cap growth stocks. Figure 1 shows that the FANG+ index is trading over 50% higher than its February high, which was mainly driven by the surge in global liquidity.
In addition, the major 5 central banks (Fed, ECB, BoJ, PBoC and BoE) are expected to increase their balance sheet by another 5 trillion USD in the coming 2 years, to a total of 33 trillion USD, to cover the high costs of national lockdowns. As a result, ‘Wall Street’ strategists have constantly reviewed their SP500 forecasts for 2021 to the upside in recent months, with the average forecast rising to 4,035 in December according to Bloomberg.
With central banks ‘ready to act’ as soon as we see a sudden tightening in financial conditions (due to a drop in equities), the risk reward in the SP500 is currently skewed to the upside with all the liquidity injections expected to reach markets in the coming months.
Even though a significant amount of investors have become increasingly worried about the current state of the equity market and how ‘extremely stretched’ the equity positioning has been in recent weeks, they must not underestimate the force of the liquidity injections coming from central banks. Figure 1 shows the evolution of the major 5 central banks’ assets since 2002 (Fed, ECB, BoJ, PBoC and BoE); after rising by over 7 trillion USD since March, assets of the top 5 central banks are expected to grow by another USD 5tr in the coming two years up to USD 33tr in order to support the high costs of running restrictive economies to fight the pandemic.
Therefore, although some fundamental ratios such as price-to-sales or the traditional P/E ratio have reached stratospheric levels for some companies and also for the entire equity indexes (for instance, Robert Shiller’s CAPE ratio was of 33.1 in November, far above its 140-year average of 17.1), the constant liquidity injections could continue to support the equity market in the near to medium term, especially the FANG+ stocks. Figure 2 shows the strong co-movement between the total assets from the major 5 central banks and the FANG+ index; we can notice that the titanic rise in central banks assets has ‘perfectly’ matched the strong rebound in the mega-cap growth stocks in the past 8 months.
With 5 trillion USD of assets expected to be added in the coming 24 months, is it really time to be bearish on tech stocks? Figure 2
Since the start of the year, we saw that the dramatic liquidity injections from central banks to prevent the economies from falling into a global deflationary depression has led to a sharp depreciation of most of the currencies, especially against assets with limited supply such as Gold, Silver and Bitcoin. The liquidity also generated a strong rebound in risky assets such as equities, reinforcing the trend on the mega-cap growth stocks (FAAMN companies). The NYSE FANG+ index, which provides exposure to 10 of today’s highly-traded tech giants, is now trading nearly 50% higher than its February peak, which has massively contributed to the recovery in the SP500.
In the past few months, we have noticed an interesting observation: it seems that the Fed (and other central banks) interventions have led to one ‘global trade’ as a significant amount of assets have strongly co-moved together in 2020. This chart shows the strong relationship between Bitcoin prices and the FANG+ index; a few weeks ago, cheaper equities due to the rise in uncertainty over US elections and the lack of stimulus has led to also lower Bitcoin prices. Are ‘Bitcoin bulls’ really hedged against a sudden reversal in equities?