V FOR VICTORY?
Public equity markets have risen to close to pre-pandemic levels and appear to be pricing in a V-shaped economic rebound. It’s very much at odds with both bond yields close to zero in most major countries and the hand-wringing we see in the media. Who is more likely to be right?
Over the last few weeks at Linchpin we’ve been sceptical. While the global economy was turned off by the politicians with the flick of a switch, our view was that it would take much more to turn it back on again. It’s not just that some business models will have become redundant but also that many of the social connections which business depend on have been broken. There are activities which are impossible under social distancing constraints. We thought a V-shaped recovery was not impossible but unlikely.
We are beginning to change our mind. Our primary evidence is the actions which governments and central banks have taken. Our friends at CrossBorder Capital have released end April data to show that (on an index of 0 to 100) global funding liquidity is standing at 81.5, ie. two standard deviations above normal. It is unsurprisingly driven by central banks, with the US and the UK in the forefront, China and Japan lagging. So far, so like the 2008-9 GFC.
The big difference is in private sector liquidity, currently at an index level of 91 compared to only 10 at the bottom in 2009. It is not hard to understand why. The total amount of public and private debt in the world today is in the region of US$300tr, much of it somewhat stale. Refinancing it is, as regular readers of this blog will know, the financial system’s major problem and around US$60tr is due for refinancing over the next 12 months. The authorities’ reaction has been to flood the private sector with liquidity, hence the very high reading on CrossBorder’s data.
The combination of these two tell us that a V-shaped recovery is much more likely than we thought a few weeks ago. US economic expectations data, where the negative balance a month ago has turned to a positive one, tells a similar story.
A swift rebound is not without perils, of course, the primary one being a resurgence of inflation. We note that narrower measures such as M1 and M2 are expanding faster than the broader ones we usually follow. For example, year on year, US M1 is +29% vs broader money +18%. That suggests inflation may take off on the high street sooner than expected.
This scenario is backed up by a steepening bond yield curve. As term premia are at extreme lows, we’d expect the whole bond yield curve (except perhaps the very short end) to rise at some point in the next six months to bring them back to normal. However, beyond that steepening is already anticipated by the current market term structure and seems baked in by central bank policy actions. Investors seem to be preparing to sell ‘safe’ assets and buy riskier ones.
The next question is for equity investors: is a V-shape already discounted in markets? We look at investor appetite data, again from our friends at CrossBorder. It tells us that currently investor appetite in both Developed and Emerging Markets are at lows not far short of where they reached in 2009. That doesn’t guarantee that markets will rise from here but it does suggest that there won’t be much further selling.
Historically this combination of the liquidity index being at a high level and risk appetite at a low level has been a buy signal for equity markets, most famously in early 2009. Of course it’s not without risk - chiefly that we’re wrong about the economy - but the fact that it’s a bit uncomfortable putting money into the market today makes us all the keener. V for victory?
To find out more about CrossBorder’s research please contact us.