The volatile market action over the past 24 hours shines a spotlight on an important question for investors: Have markets lost part of the liquidity anchor that not only allowed them to brush off a number of negative influences but also pulled stocks higher to one record after the other?
The issue becomes all that more important given the continued uncertainty facing the fiscal relief package and Thursday’s jobless claims numbers.
Going into the Federal Reserve’s statement and press conference on Wednesday, there were already signs of less reliable price support from what had been a highly influential inflow of retail investors. Its impact, while still notable, has been shrinking gradually from the broader market to a narrowing set of specific companies.
Despite this, skeptical investors’ appetite to challenge what they regard as elevated valuations remained repressed by their experience with, and respect for, ample and repeated Fed liquidity injections. And it wasn’t just because the Fed has been keeping the cost of leverage and borrowing very low, has been buying trillions of dollars of securities (including higher-risk junk bonds) and has been pushing investors from government bonds into higher-risk assets.
The Fed’s repeated support for financial markets has engendered a deep “buy-the-dip” investor conditioning and a prominent FOMO mindset.
Although the Fed did deliver again for riskier assets with a more dovish-than-expected policy statement on Wednesday, the markets’ feel-good reaction evaporated during the press conference that followed. Several reasons have been cited for this, including the cautionary tone taken by Chair Jerome Powell and the way he addressed the prospects for fiscal policy.
They also include his seemingly tentative responses to questions on the effectiveness of the central bank’s tools to meet the de facto more ambitious inflation target, on the contrast between the specificity of the outlook for interest rate policy (high) and asset purchases (low), on the challenges facing the Main Street Lending Program and on the outlook for financial stability
. This adds to the long-standing concern that the more dovish the Fed is, the less likely lawmakers in Congress will agree on a new relief package.
Now with the Fed essentially on the sideline for almost two months — the next FOMC meeting is scheduled for Nov. 4-5 — the more skeptical investors may now feel more comfortable to challenge valuations.
There seems to have been some evidence of that already in the markets’ all-day tug-of-war on Thursday, with a weak carryover open attracting buy-the-dip investors only to have the resulting bounce in stock prices bring out sellers rather than the usual crowd of FOMO buyers.
All of that brings us back to the importance of fundamentals and policies.
To be sustainable, elevated valuations will need to be validated more by improvement in economic and corporate fundamentals. As Thursday’s jobless claims numbers suggested again, the economic recovery continues but at a pace that is too slow relative both to what’s possible and what’s needed.
Unless Congress steps up to the responsibility of taking timely action to support both the demand and supply side of the economy, specifically through the four distinct channels I have written about before, the risk increases of a missed market hand-off from previously strong but fading liquidity to what’s urgently needed also for economic and social well-being: A strong lasting and inclusive recovery.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'
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