The one chart that explains why global equities have tried to rally this week

“No-one knows for sure whether this week’s spectacular rally is a sign that the bottom is in or the first of a series of vicious traps during a prolonged bear market but one chart makes it easy to understand why investors are looking at financial assets once more,” says Russ Mould, AJ Bell Investment Director.

“Thanks to its latest interventions in the interbank funding, or repo, markets and launch of a fourth, unlimited round of Quantitative Easing, the US Federal Reserve’s balance sheet has swollen by a fifth in just two weeks to $5.2 trillion. That also means the central bank’s assets are a third higher than they were a year ago.

Source: FRED – St. Louis Federal Reserve database, Refinitiv data

“This matches the rate of growth witnessed in late 2013 and early 2014 (after the Fed had been running QE-3 at a rate of $85 billion a month for over a year) and follows the path of QE-1 back in late 2009 when the Fed’s balance sheet swiftly doubled.

“It took some time but eventually the cheap liquidity provided by the Fed began to look for a home and it did so in the financial markets, because interest rates on cash and bond yields felt so low (and they are even lower now).

Source: FRED – St. Louis Federal Reserve database, Refinitiv data

“The Fed began QE-1 in November 2008 but the S&P 500 did not bottom until March 2009, after a couple of failed bear market rallies.

“It seems logical to expect financial assets to respond to this tidal wave of liquidity at some stage, too. Granted, valuations are much higher now than they were back in 2009, looking at ratios such as market-cap-to-GDP and the Shiller cyclically-adjusted-price-earnings (CAPE) multiple and the news on the economy and earnings are likely to get worse before they get better.

“But once news flow stops deteriorating and confidence returns – as it surely shall – then watch out because the Fed’s liquidity gusher could easily create a bubble that would make those of 1998-2000, 2005-07 and 2018-20 look like small potatoes by comparison, if the monetary authorities are not careful. And on the basis of what we saw in the 2010s the odds on central banks being bold enough to withdraw stimulus once it is no longer needed are somewhere between nil and slim – and Slim just left town, as the old saying goes.”

These articles are for information purposes only and are not a personal recommendation or advice.


The chart of the week is written by Russ Mould, AJ Bell’s Investment Director and his team.