The stock markets had a highly satisfactory year in terms of index growth, with nearly all major stock markets recording double-digit gains. Considering the complex geopolitical landscape that characterized the period, along with fears of a possible recession caused by European and US monetary policies, which only aligned toward the end of the year, the results achieved are surprising. The positive performance of the stock markets is primarily explained by the expansionary cycle of systemic liquidity, which likely reached its peak for the period at the end of the year, at least in the United States.
It is no coincidence that in recent months, the Fed’s Board of Directors first officially declared the end of the credit tightening phase, evidenced by the gradual reduction of its balance sheet, and more recently, Governor Powell indicated the possibility of further reductions in the key interest rate, measures aimed at supporting liquidity. Indeed, some signals from the private credit sector indicate a certain tension that would be corrected by a slightly more accommodative monetary policy. These developments have worried the market, which has linked them to President Trump’s ongoing criticism of the Fed’s actions, in that the government is aiming for an interest rate in the 1% range to stimulate economic growth before the midterm elections. Investors fear that the central bank might unjustifiably reduce its key interest rate, relative to economic fundamentals, causing a resurgence of inflation and a steeper yield curve offered by the dollar. In reality, even the appointment in May of a new Governor closer to the President’s position would not have significant effects given the number of members of the Board of Directors, not to mention that practice shows that it is long-term rates that influence short-term rates, not the other way around. Therefore, the yield curve could flatten rather than steepen because the gradual reduction in systemic liquidity would lead to increased demand for long-term government bonds in response to a reduced appetite for risk, thus reducing the duration premium inherent in the yields offered, which in turn would reduce inflation expectations. An important characteristic of liquidity spikes, such as the current one, is that they coincide with a phase of economic acceleration, as the remaining liquidity is shifted from financial assets to the real economy. This hypothesis is also supported by the observation that during the current presidential term, the contribution to economic growth from the AI sector will continue to remain significant.
Combined with the ongoing accommodative fiscal policy, the outlook for US GDP growth appears more than satisfactory, reducing the downside potential for the cost of money and making a flat yield curve likely. The implication for stock markets of this US scenario are that the underlying positive trend is set to continue thanks to prospective economic growth, the maintenance of systemic liquidity levels at least in the first half of the year, and the stabilization of long-term yields. European stock markets also nurture attractive potential thanks to the positive contribution to growth from Germany’s impressive public spending increase plan, only partially reflected in prices. From a tactical perspective, a correction from overbought conditions is possible in the first quarter, which would lead to an increase in equity exposure.
Nicola Bravetti Data Source: Bloomberg
“This report cannot – nor can – be consider a solicitation to invest in financial instruments.”