A year unlike any other for most of us around the world will be remembered in the US and international financial markets for five major characteristics:
The great disconnect between Wall Street and Main Street: Aside from a few weeks that culminated in the market lows of March 2020, stocks have managed to ignore what has been a drastic collapse in global economic activity with significant immediate and long-term consequences. This incredible decoupling has shown no signs of slowing down even as the markets are trading at historically high valuation levels. On the contrary, an exceptional disconnection has become more important. Stocks set one record after another, as economies faced another wave of covid.
Chasing Price Action Explanations: Unless you, like me, believe in the overwhelming influence on markets of abundant and predictable liquidity from central banks, especially the US Fed and the European Central Bank, it has been hard to find a narrative sustainable to explain and predict this year. exceptional prices. Indeed, rather than narratives driving market action, market action led to consensual explanations that often turned out to be inconsistent. There are several examples, including three conflicting political narratives that were widely adopted in mid-2020 by market participants to “explain” the steady rise in stocks: Strong prospects for President Donald Trump’s re-election with a reduction program taxes and regulation; a divided government that would keep it out and allow businesses to thrive without interference; and a wave from the Democratic Party that would translate into huge fiscal stimulus that would stimulate demand.
The phenomenon of double liquidity: In 2020, investors experienced illiquidity in the largest and traditionally most liquid markets and liquidity in generally illiquid segments. More precisely, the month of March will be remembered as the moment when even the flows to US Treasuries were severely disrupted. Weeks later, the Fed’s intervention in the markets, including surprise purchases of high-yield securities, injected liquidity everywhere and prompted “crossover” investors to venture far from their normal habitat. By the end of the year, the deep conviction in an eternal “central bank put-down” meant that, of all the risks investors face, those associated with liquidity once again became the most underestimated.
Risk mitigation research: The more successful central banks were in suppressing market returns on “risk-free” government bonds (and confronting investors with little or no income and unfavorable asymmetric price risk), the more investors looked for ways new and more appealing to mitigate risk – so much so that a growing number of market commentators have commented in 2020 on the predicted demise of the traditional 60/40 equity bond portfolio. Many investors, especially those facing negative yields on government bonds, have ventured into other areas of the fixed income market in an attempt to offset the risks associated with their large equity positions. What began as purchases of short-dated investment-grade bonds – assuming the Fed put them under a protective umbrella with its own purchases – has evolved to include debt with much higher risk of default. , such as high yield bonds and some emerging market bonds. Others have taken a more basket approach, adding gold, Bitcoin, and other cryptocurrencies. o government bonds.
No accidents in emerging markets: Emerging economies found themselves in a perfect economic storm due to the disruption of covid. As a result of the “sudden shutdown” of the global economy and the uneven geographic recovery that followed, many have seen export earnings collapse, tourism earnings disappear, and foreign direct investment inflows s. ‘evaporate, some even being faced with the prospect of exits. Yet, with the exception of pre-existing condition countries such as Argentina, Ecuador and Lebanon, the vast majority of emerging markets have avoided debt defaults and major restructurings. Indeed, with the rapid return of liquidity to financial markets and investors seeking higher returns, a level issued at risk spreads and exceptionally low overall returns.
Combined, these five factors add up to a year that gave investors much of what they could want, especially in terms of nice returns with particularly low volatility (outside of March). These are also factors that testify to the dominant influence in the market of central banks, which anchor an unhealthy codependent relationship that most investors wish to maintain, regardless of declining benefits to long-term economic and financial well-being. , as well as collateral damage and the spread of unintended consequences.
Mohamed A. El-Erian is Bloomberg Opinion Columnist, President of Queens’ College, Cambridge and Chief Economic Advisor at Allianz SE