Monday, July 1, 2019

Liquidity serves. Liquidity manipulates. Liquidity dominates. Just follow the liquidity without care.

After difficult May return performance, markets rebounded to touch new highs for the year and reverse any risk-off thinking. Equity markets around the world have generated double-digit year-to-date return numbers based on their ongoing perception that central banks will flood the market with liquidity if there are any signs of financial market unrest.  The liquidity is all but baked in based on market expectations. There are signs of a weaker economy albeit weaker is not the same as being on the verge of a recession. Deceleration is normal and swings of one percent in growth on slower growth economies can be look exaggerated on a percentage basis, but liquidity dominates financial market thinking. This is why the correlation between economic growth and financial returns is not as high as expected. Other factors often matter more. Using real economic data without considering liquidity gives a wrong financial picture.

Investors who followed the “forward guidance” that central banks will provide a financial put have been rewarded. Investors who have looked closely at the real data or have responded with caution concerning uncertainty have been penalized. These may not be the lessons that should be internalized but these are the reward signs we have been received.

Investors that have followed caution have not been rewarded albeit fixed income returns still look good. Those who have tried to time this market through either following prices or economic signals have not been rewarded. The reversals in markets have often been too fast to adjust. The buy and hold investor, classic 60/40 stock bond, have been rewarded with double-digit returns.

Markets can and do get ahead of themselves. With expectations of multiple Fed cuts, there is only room for disappointment if these liquidity signals are not realized. Saying there is more room for disappointment is not some contrarian spin but the reality that things that cannot go on forever won’t. 

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