This excess of liquidity and free money in the system cannot now come out without consequences, despite attempts by the Federal Reserve to say otherwise.
September 26, 2021
As vaccines roll out, we edge closer towards seeing the light at the end of the tunnel and the end of the pandemic. We still have a way to go, but there is hope that immunizations will help in getting life back to normal.
Looking back, one thing that stands out from an economic perspective, has been the inordinate amount of liquidity that has been pumped in by central banks to do anything in their power to make sure equities and asset markets did not collapse.
As a result of this, it is a very tricky time for economists and they are struggling to predict even basic economic variables such as growth and inflation. For an economy to work efficiently there are normally certain things we can rely on. When stocks go up, government bonds and gold should go down. There is (normally) a finite amount of money in the world and if riskier investments are rising, safe haven assets should go down. It’s a well-balanced machine that just makes sense.
However, what happens when that finite amount of money suddenly becomes, well, infinite. Governments have pumped in excess of $30 trillion into the world economy. They have handed out free cheques to boost consumer demand and support jobs.
This excess of liquidity and free money in the system cannot now come out without consequences, despite attempts by the Federal Reserve to say otherwise. Much of this liquidity, has found its way into the equity market as bored stay at home citizens find other means to entertain themselves, hence, the rise of online retail traders!
Arguably, in some areas, it has gotten out of hand. The fact that retail, and their leveraged positions they may not all understand, can group together and take down hedge fund short positions is not particularly helpful. Having said that, we are seeing a reversal in most of the ‘power to the people’ stocks as they’ve had their fun, and maybe it is time to move on.
This, however, raises interesting questions as to whether the beneficial result for markets will compound or, instead, involve volatile contradictions requiring careful active management. Powered by ample and predictable liquidity injection, investors set aside many traditional economic and political influences as the Fed vacuumed up securities at non-commercial prices.
The indirect effect has conditioned investors to buy every market dip, whatever the cause, and allocate more capital into ever riskier investments. In his recent remarks, Fed chair Jay Powell has made it clear that the central bank has no intention of changing this policy approach, be it the large-scale purchase of securities (currently running at $120bn a month, or about 7 per cent of gross domestic product on an annualised basis) or rock bottom policy rates.
So, what does this mean for the market now? Well, if the money keeps on coming, and retail trading is a trend that only grows, and we think it will, more and more capital will find its way to equities, and to some extent, cryptocurrencies. Most inexperienced retail traders will only really look at these two as there is an enjoyment to picking stocks they know and love, and there is the thrill of buying into a new world order that is crypto.
Bond yields are up, which means the price of buying a government bond is lowering daily. Big tech has been hit hard at the same time. This has confused and panicked the market a little, but to be honest, it’s an inevitable consequence of something called hope!
Many economists are making the mistake of thinking that the big tech companies are like normal equities, they aren’t. When stocks were collapsing, big tech started its rise quickly afterwards. I wrote in an article last summer that a lot of big tech buying was because they are to be considered safe havens. Exactly what we said would happen, did happen. Yes, arguably the prices in big tech are still too high, but these are many of the world’s richest companies so it is still a safe place for money and for now, even after a dip, they will remain high.
We have seen 6% fall off the Nasdaq over the last couple of weeks. Big tech, is falling and government bond prices are falling. This also makes sense if both are safe haven assets. Financial commentators are up in arms at high stock prices, but they aren’t seeing the picture correctly. Moving cash into Apple is not all that different to buying Treasuries, only the former might actually pay you a return.
Therefore, big tech and Government bond prices falling together, is a good sign. Don’t panic. There is a lot more money now in the system and it needs to be moved around to re-establish the equilibrium. Retail may hold up tech to some degree and inflated tech valuations are now the norm, but smart institutions are selling out and rebalancing their global equity books.
The question is, where does the money go now? Well, our call would be it starts to make its way into undervalued stocks that have been hit by the pandemic. All the more reason why now is the time for a well managed and active equity portfolio. Those who do nothing, make nothing. UK equity funds were down an average of -10% last year. Portfolios on The Portfolio Platform were up an average of 49%.
The buy and hold mentality will work over many years if you have decades to wait, but to increase return you need to be proactive. Let The Portfolio Platform be proactive for you. Link your account to one of the many incredible traders and watch how an actively traded stock portfolio can increase your return on investment.
This article was brought to you by The Portfolio Platform, a investment platform designed by professional traders, for the retail market. You can now autotrade their strategies and capitalise on opportunity.
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