Tightening By Any Other Name
Two weeks ago, we observed that peak liquidity growth had already passed:
“There is an important sense in which the taper already began in the first quarter. The Fed may not be withdrawing liquidity from the system, but the rate at which liquidity is increasing (that is, the ‘second derivative’ of liquidity growth) has declined sharply… A difficult, volatile, or choppy period for markets is likely to prevail as [money supply] growth continues to slow to a level closer to its pre-pandemic norm.”
This is not true only where the U.S. Fed is concerned. Aggregate liquidity growth across major global central banks over the past three months has run at a 6.5% annualized rate — which is back to pre-pandemic levels. Last year at this time, the annualized three-month rate of liquidity growth was 54% (it had peaked at a mind-boggling 95% pace a month earlier). The U.S. Fed, the European Central Bank, and the Bank of Japan are all slowing — the latter two sharply. Only China is accelerating.
Don’t Fear the Dips
Liquidity growth has been the driving force behind the markets’ recovery from the pandemic recession lows. Where accelerating liquidity growth has undergirded markets, and sometimes-euphoric market sentiments, decelerating liquidity growth is likely to cause one of those “pauses that refresh” which investors can easily believe will be healthy and normal — until they actually happen.
Further, as we noted above, all eyes will be on the Fed’s Jackson Hole gathering. We believe that economic performance, and particularly employment growth, will have been so consistently strong by late August that FOMC members may well begin talking somewhat more directly about tapering — and while we haven’t had a “taper tantrum” yet, that could precipitate one.
In our view, that would be a dip to buy, given the strength of the U.S. economic recovery. (Though see our comments on earnings below.) Federal monetary and fiscal support have become so strategically entrenched in market structure and market participants’ consciousness that we do not believe we are headed towards a future where such interventions become less common. On the contrary, they are highly likely to continue to make market corrections briefer and shallower, and keep the opportunity costs of preemptive caution high.
Market Leadership and Earnings Season
The question remains who will benefit. As we observed last week, the market’s new highs on a market-capitalization weighted basis have served to conceal significant rotation among sectors and themes; the “average stock” as revealed by the equal-weighted S&P 500 index has moved sideways for months. We are attentive to these shifts. For now we remain focused on the tech-centered leaders, differentiating those which are more expensive and those which sell at more compelling valuations.
Earnings season is once again around the corner. With recovery expectations now getting baked into analysts’ estimates, a significant leg higher for markets is going to require more on the earnings front than market participants have expected hitherto. Peaking liquidity and rising expectations together will mean that investors will expect more in order to move the needle than they have expected during the post-pandemic rally so far.
China Brings the Hammer Down
We have written in the past about the innovative tech leaders of China — many of whom, leapfrogging directly into a hyper-networked, mobile world, have spearheaded cross-platform models that in sheer creativity are the equal of the best U.S. tech leaders. We would never gainsay the ambition and capability of China’s tech entrepreneurs.
On an investment basis, though, we have harbored reservations about the reliability of the Chinese government in guaranteeing that their tech leaders could operate under the rule of law. China’s actions against ride-hailing leader Didi Chuxing [DIDI] just after its U.S. IPO vindicate this suspicion, and will cast a pall — to say the least — over U.S.-listed Chinese tech firms. The chilly reception of Chinese firms listing in the U.S. now seems to be becoming policy and attitude among both Chinese and U.S. politicians and officials.
Thanks for listening; we welcome your calls and questions.
