Morgan Stanley: It’s Fair To Say That The Market Rally Is Due To The Fed’s QE4
Morgan Stanley’s Michael Wilson, who in 2018 was the most bearish and accurate of all sellside analysts, fought the Fed in 2019 and the Fed won.
One week ago we quoted from Wilson’s latest weekly report, in which the now quasi-bullish strategist explained why he had grudgingly turned bullish, saying “we continue to see the 3 largest central banks in the world expand their balance sheets at the rate of $100B per month ($60B from the Fed, $25B from the ECB and $15B from the BOJ).” As a reminder, several years ago, Citi’s fixed income guru Matt King said that it takes $200 billion in quarterly liquidity injections across all central banks to prevent a market crash, and lo and behold we are now well above that bogey.
Wilson continued, pointing out that “as part of our year ahead outlook published a few weeks ago, we cited this excessive liquidity as a reason why we thought the S&P 500 could trade well above our bull case year end target of 3250 while this policy action persists. As of right now, it appears that the Fed, ECB and BOJ will continue at this pace through the first quarter of next year.”
The Morgan Stanley strategist then also laid out how central banks directly affect risk assets, noting that “the central bank transmission mechanism is via suppressed volatility” and ading that “the recent actions by the Fed were intended to reduce volatility in the repo market but it’s also had the effect of reducing the volatility in risk markets.” Little did Wilson know that just a few days later, the Fed would announce a record $490 billion in year-end liquidity backstops in the form of expanded overnight and term repos to avoid a year-end repo market crisis and to keep repo rates low on Monday when about $100 billion in systemic liquidity would be drained as explained previously.
And, as Wilson correctly noted, this massive tide of liquidity which would push the Fed’s balance sheet to a new all time high in just a few weeks, was quickly used by the market to send the VIX tumbling to an 11-handle, with single-digits in the VIX’ immediate future now virtually unavoidable.
Fast forward to today when Wilson – still sore from flipping from a raging bear to a reluctant bull – is out with his latest note in which he notes that following the recent “trifecta of positive catalysts”, market sentiment has been driven higher on “trade and Brexit” but it is the “liquidity from central banks is the main actor in this bull run.“
Sounding awfully like a tinfoil conspiracy blog, here is how Wilson explains why no risks and headwinds – and there are quite a few – matter thanks to the “extraordinarily accommodative” central banks:
The approximately $100B/month of balance sheet expansion from the big three central banks (Fed, ECB and BOJ) is now being further enhanced by the Fed’s overnight repo operations which are expected to increase to $490B by year end. In short, we don’t expect any liquidity issues between now and year end with that kind of money flooding the system. And, while the repo operations won’t have a direct impact on risk markets, we do think the Fed’s $60B of bill purchases and the ECB and BOJ QE operations are absolutely suppressing volatility across most risk markets, including equities…
… in the process pushing stocks to all time highs.
The bottom line is that just months after Morgan Stanley downgraded global stocks to a Sell, only to reverse itself four weeks ago, Wilson is rapidly emerging as one of the market’s biggest bulls, not because he wants to but because the Fed has forced him to. As he says, he is now “very bullish on liquidity support being provided currently by the Fed and other central banks. While we can’t quantify the exact impact it is having on asset prices, we remain confident that it is suppressing volatility, which is attracting new flows to risk assets from systematic strategies and driving prices higher and attracting other investors, particularly at year end when performance anxiety is greatest.”
Wilson then uses the following chart showing the significant y/y rate of change that occurred in the Fed’s balance sheet this summer and fall…
… highlighting that this -miraculously – coincided with the time recession fears were peaking as well (but don’t call it QE 4 – “everyone knows” the Fed will only inject $1 trillion in liquidity in the Sept-Jan period only to fix the repo market, and it has “nothing” to do with anything else, like goosing stocks).
Wilson then muses rhetorically “how much of the powerful rally from September is due to the rate of change on growth bottoming and how much is due to this almost unprecedented rate of change in balance sheet.” Incidentally, there is no doubt as to the answer: on Friday we showed another uncanny chart: in the 9 weeks since the Fed launched QE4, the S&P is up every week the Fed’s balance sheet is up, and is down just one week – when the balance sheet shrank.
As for Wilson’s own answer, here it is: “it’s fair to say that [the rally] may be more due to the balance sheet reversal [i.e. “NOT QE”, also i.e., QE 4] than fundamentals since the real signs of bottoming have come from international PMIs rather than the US.”
Having identified the culprit behind the move, Wilson then echoes BofA’s Hartnett who as a reminder expects the S&P to hit 3,333 by March 3, saying that the meltup is likely to continue “with the Fed scheduled to keep expanding its balance sheet by $60B /month through the first quarter” which the MS strategist concludes is “a powerful positive force that can take stocks well above fair value between now and then.”
And “then” what? Actually ignore that: the real question is just what is the “fair value” of stocks when one strips away not just QE4, but also QE3, QE2, QE1, and trillions in QE from other central banks. Luckily, the market will be permanently halted long before we will ever find out.