The Federal Open Market Committee meets again today to dispatch the latest wisdom on matters monetary. By and large, the market thinks that Fed funds will remain unchanged at 5.25%.
Doing nothing may seem to be the wisest choice at the moment, but no one should underestimate the complexity of the current global economic climate. One factor that’s skewing perceptions and modifying valuations is the mountain of cash looking for a home. There is an enormous amount of liquidity sloshing around, both domestically and in foreign economies. The magnitude of the liquidity is unprecedented, and so its impact on the capital markets and economic conditions are yet fully understood.
In light of the bull market in liquidity, the main questions for strategic-minded investors are: Is it really different this time? and if so, How’s it different?
As we wrote last week, 2006 is shaping up to be the fourth year running that all the major asset classes post gains. That hasn’t happened since 1996, and the record of multi-year bull markets across the board is even more infrequent and probably unique (although we don’t have all the data to confirm the latter). But no matter how you slice it, these are extraordinary times and we’re confident that it’s due partly to extraordinary liquidity.
The Economist this week wrote that the combination of the petrodollars born of crude oil sales and China’s export machine is enormous. What’s more, the petrodollars dwarf even China’s export-driven cash stash. “At the global level, the biggest counterpart to America’s deficit is the combined surpluses of the oil-exporting emerging economies,” The Economist advised. “They are expected to run a total current-account surplus of some $500 billion this year, dwarfing China’s likely surplus of $200 billion.”
When America pays oil exporters and China dollars in exchange for energy, electronics and other goodies, where do those dollars go? A fair chunk is reinvested back into America by purchasing Treasuries, stocks, and an assortment of other assets. This liquidity is sufficiently large so as to alter the capital markets. How’s it altered? That’s a matter of some debate, but we have our suspicions, starting with the strange state of affairs that’s delivered bull markets across the board in all the major asset classes. Would such an astonishing run of bull markets survive without the degree of global liquidity?
Investors must decide if the mass of global liquidity will keep bubbling and flowing into all the asset classes, regardless of valuation. As challenging as that question is, it’s all the more prickly if, as some predict, the economy will materially slow in 2007.
The last several years have been extraordinary, but even strange days evolve and eventually end. Timing, as always, is the big unknown. But that doesn’t stop us from guessing. And by our watch, the hour is late.