Liquidity driven narrative remains intact but Gold knows there is no V-shaped recovery

Risk appetite is consolidating with the rising COVID-19 case count still prevalent across many nations but the medium term liquidity driven narrative remains intact. Although the persistence of the virus reminds us that COVID-19 is very much “here to stay” until a vaccine is found, without fresh lockdowns the bullish momentum across the risk asset spectrum is set to continue, with setbacks part of a broader rising trend. As has been the case for many weeks, the narrative on the ground is not truly driving risk assets, although there are moments when reality collides with stimulus driven sentiment.

As we have discussed prior, the hope trade that has been unleashed as central bankers bid to backstop almost every asset class, providing abundant liquidity to financial markets with the promise of more as when is necessary, provides a powerful force to be reckoned with. G5 Central Bank balance sheets have expanded at a rapid pace, well beyond measures taken in prior downturns, which has to date proved successful in detaching risk asset pricing from fundamentals. In short, there is too much liquidity chasing too few assets. Moreover, although Central Banks are not mandating ever inflating financial assets, the Fed have implied they remain accommodative at all costs, incipient bubble or not. A recovery that lags expectations, a 2^nd wave of COVID-19 with lockdowns re-imposed once colder weather returns, fiscal cliffs, persistently high unemployment, geopolitics – any number of downside risks will be met with action from Central Bankers and the Fed have exhibited their pain threshold is relatively low.

Regular readers are well versed in that the mechanics outlined above, manifest in a powerful force that continues to drive risky assets higher - the lack of alternative (TINA). That is the alternatives to equities look very unappealing (unless its gold!), this coupled with the expectation that rates will remain low for an extended period and the question of YCC for the Fed turning to when, not if, drives investors up the risk spectrum into equities. Essentially giving a green light to the “hunt for yield”, along with a dose of moral hazard. As we have said before, the existence of this dynamic perversely dictates one need not be positive on the expectations of a swift economic recovery, to be long stocks (and by default short efficient markets/price discovery).

Another driver remains, when rates are lower or capped at lower levels in the case of YCC, the market values future cash flows more richly and the effect on valuation is explicitly positive. For technology stocks with less debt, higher free cash flow yields, and earnings duration profiles with high forecast future cash flows the expectation of YCC and rates remaining low gives another green light to continue to buy this sector. The Nasdaq 100 hitting fresh record highs overnight is a direct product of these mechanics.