Absent a year-end meltdown, stocks will have enjoyed a stellar year. That stocks would post +20% gains was not obvious back in January, when investors were preparing for some combination of a recession and trade war. What saved stocks? It has not been stellar economic growth or a surge in corporate earnings. While the recent easing in trade tensions has helped, what has really saved stocks is what has worked time-and-time again this cycle: monetary easing.
Back in early September I highlighted the tug-of-war between geopolitical uncertainty and easier financial conditions. At the time I suggested that better liquidity would likely support risky assets. Since then global stocks have risen by approximately 6%, with riskier parts of the market, notably emerging markets and technology, rising roughly 8%.
Today I would make the same argument: Liquidity is likely to beat uncertainty, or at least until early 2020. I would cite three reasons in favor of this scenario: some easing of geopolitical risk, accelerating liquidity on the back of expanding central bank balance sheets and the likelihood that better liquidity will lead to economic stabilization.
- For now, geopolitical uncertainty is receding. Geopolitical risk appears to be fading, at least from the summer peak. The BlackRock Global Risk Index has fallen by around 20% since August.
- Global liquidity is improving. While the Federal Reserve may take a break from cutting rates, most measures of financial conditions are improving. In particular, central banks are once again buying assets. The European Central Bank (ECB) has resumed its quantitative easing program and the Fed, partly as a response to recent dislocations in the money markets, is once again expanding its balance sheet. As a result, the cumulative balance sheet of the Fed, ECB, Bank of Japan and Bank of England is rising for the first time since 2017.
- Better liquidity suggests stabilizing growth. The improvement in global liquidity should lead to improving, or at least more stable, growth. Looking at the BlackRock Financial Conditions Index suggests growth estimates are likely to accelerate during the next quarter (see Chart 1).
What could change this dynamic?
Either a more hawkish tilt by central banks, which is highly unlikely in my opinion, or a rise in political uncertainty would be the most likely candidates. That said, for uncertainty to have a meaningful impact it will need to lead to a reduction in business and consumer confidence. In other words, political uncertainty itself is unlikely to disrupt financial markets unless there is some evidence that it is impacting the behavior of companies and consumers. If it were to rise to the point where it did so, that would be a game changer.
That said, for now, hiring remains robust and consumers continue to spend. In this regime greater liquidity should prove an effective balm for the occasional case of geopolitical jitters.