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.