George Lucas, Raiz Group CEO
This week saw US equities continue to lead the worldwide rush into stocks that has almost doubled the MSCI All-World share index, which tracks equity performance in 50 nations, since March 2020.
This is one of the most powerful runs for global equities in history, with the S&P 500 this week sealing its longest streak of hitting record highs since 1964, before pulling back slightly.
At the same time, speculative digital assets such as bitcoin and “meme coins” like Shiba Inu have shot higher, taking crypto market value to about $3tn from less than $500bn at this time last year.
There appears to be a lot of FOMO in the financial markets.
Central bank stimulus fuels global growth
Obviously, a key driver of the rally has been the deluge of central bank stimulus measures taken to steady the world economy during the pandemic last year, ensuring a strong economic rebound.
Additionally, the upswing in financial and cypto markets appears to have been supercharged by a boom in retail trading that began when many people faced severe social restrictions last year. This has continued even as economies reopen.
Rising signs of euphoria in stock market
The performance of these risky assets could also be a warning sign that the stock market is becoming somewhat detached from reality, or euphoric. So prepare now for a good downturn in March 2022.
Another sign of increasing euphoria is the equity options market in the US. Earlier this month a record $2.6tn worth of options — derivatives that enable investors to make magnified bets on or against stocks with borrowing — changed hands in the US, the highest trading volume on record.
Again, retail investors are a major factor behind the surge in option trading. Even professionals and central banks don’t fully understand risks associated with options, let alone retail investors.
So buckle up. Globally, $865bn of new money has been pumped into equity funds this year, according to financial intelligence service EPFR. That is already almost three times the previous full-year record, and more than two decades’ worth of combined inflows tallied by the data provider.
Market rally could continue into year’s end
Looking ahead, the rally should continue in the US for some time yet, especially as US companies start buybacks after the enforced blackout when quarterly earnings are reported. Fund inflows also tend to be strong in the final stretch of the year, with stocks typically rallying into year’s end.
The dampener could be the options/derivatives issue. With options/derivatives at some point there is leverage on bank balance sheets and this leverage is sensitive to changes in interest rates.
So, if we were experiencing the highest level of inflation in decades — like the US is now — interest rates typically increase, bank funding costs rise, liquidity tightens and the market pulls back.
But, like farming, these liquidity events are seasonal – around March and September — so we’ll likely have three months before significant pressure will be put on markets again.
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