The Week Ahead: All we want for Christmas is…more liquidity?

US stocks advanced to another fresh all-time high Friday, securing its fourth straight week in positive territory and its seventh advance in the last eight days. The S & P had its best weekly performance in more than three months. 

A thawing in trade tensions has certainly contributed to strong gains for stocks this month. Markets are set to turn quieter now in the festive period, but focus will be on progress or lack thereof toward the formal text of the US-China phase one trade deal. There has been no date scheduled for an official signing and key details around enforcement mechanisms and timelines towards full implementation remain scarce. We have previously expressed some surprise too at the unrealistic pace of Chinese buying of US exports, particularly US agricultural commodities. 

Nearly everyone on Wall Street has underestimated the strength of this year’s stock markets. Investors have been spooked by a myriad of headwinds and yet, the markets continue to set new record highs. Equity indices are up year-to-date by more than 20% across most countries and the Stoxx Europe 600 has clocked the best year since 2009.

Of course, we had a broadly similar equity rally two years ago but that was fuelled by the synchronised pick-up in global GDP – a classic ‘risk-on story’ if you like. This time around, bonds and fixed income have also delivered solid returns with high single digit returns for euro area sovereign and high-yield debt among others. 

This year’s story is all about the monetary policy (QE) driven rally, particularly fuelled by the Fed following last year’s final quarter sell-off. Indeed, one of the most striking aspects about 2019 is that it marks the fastest pace of central bank easing since the GFC. This has cushioned the blow of contracting global manufacturing, unsteady business confidence and falling capital investment. 

How much longer can central banks extend the business cycle and confirm these stock market valuations? A de-escalation inUS-China trade tensions and Brexit clarity will help going forward but tariffs are still in place, uncertainty around the US election cycle looms large while service sectors are fragile. Add to that a slowing Chinese economy and global disinflationary pressures and headwinds are still present.

The most recent policy meetings of both the Fed and ECB were encouraging for those looking to see the central bank safety net extended. Balance sheet expansion will be maintained which means with bond yields entrenched, the low yield environment will persist and continue to favour stocks.Stock buybacks also continue to support equity markets with this year on track to be one of the most active on record, after companies spent a record $800bn buying back shares in 2018. The market has certainly grown used to companies repurchasing their own shares and providing support to the market. 

Stock markets have a record of pricing in today what will happen in the economy in the future. Cautiousness remains a theme for next year especially as the S&P500 is on track to show a third consecutive quarter for negative year-over-year growth. But there seems to be no sign of any late cycle liquidity withdrawal on the horizon, which suggests that historically low rates and persistent stock buybacks may keep stocks elevated.