2019 was a stellar year for risky assets, with the surge of equity indices posting gains above 20% in almost all regions, with a special mention for the Nasdaq, up 35%. Recession fears of January 2019 abated as central banks reversed their monetary policies, moving from a hawkish stance to a new round of ultra-accommodative actions, notably in Europe where the ECB relaunched a Quantitative Easing (QE) programme of EUR 20 billion of assets purchase per month. The Fed also participated in the liquidity injections by adding billions of dollars in the repo market on a monthly basis, even if they refrain from calling it QE. Moreover, at the end of last year, two big geopolitical uncertainties dissipated as the US and China agreed on a phase one deal and as fears of a hard Brexit were drastically reduced after Boris Johnson won the UK elections by a large margin.
Did the macroeconomic indicators justify the rise in equity markets? Well, at least we noticed some improvement at the margin. In Europe, it appears that the momentum is becoming more positive, as highlighted by the Citigroup macro surprise index, rising to 43 from a depressed level of -80 back in October last year. Nevertheless, we should keep in mind that GDP growth in the region has been slashed to 1.2% (according to Bloomberg) and that manufacturing activity remains in the doldrums, with the PMI indicator at 44.6, well below the neutral point (50). This negative development is slowly affecting the German economy as well as the labour market, as evidenced by the last unemployment change (+8k).
Did companies’ earnings per share (EPS) growth warrant the surge in risky assets? The answer is no. Indeed, we have been witnessing a sharp earnings slowdown in 2019 across different regions, ranging from negative growth in emerging markets (-9%) to a meagre growth of around 2% in Europe. Therefore, almost one hundred percent of the 2019 market price appreciation was driven by multiple expansion.
So, what has been the most important force behind such a rise in risky assets? We would argue that liquidity injections and accommodative central banks have been the main driver of solid equity returns. Based on the Bloomberg global proxy money supply indicator, which sums up M2 for the main regions, the picture is clear: in 2018, liquidity removal was damaging for the S&P 500 while in 2019, the opposite was true, i.e. a sharp increase in aggregate money supply explained solid returns.
2019 was the year of relief, as many investors feared the worst was yet to come, namely a global recession. 2020 must therefore be the year of delivery, as both earnings and macro data cannot disappoint, given the high level of expectations. We are living in a new environment where there is a greater dependence on liquidity rather than fundamentals, and this decoupling cannot extend forever, as central banks’ ammunitions are becoming more limited.