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Liquidity runs dry

14072020_fed iquidity

Liquidity runs dry

When the stock market sold off dramatically in March this year the US Federal Reserve responded by pumping financial markets with liquidity for the next three months and the stock market rocketed. But the Fed’s role in financial markets has moderated recently and signals that share market investors should proceed with caution.

By the beginning of this year the US Federal Reserve’s total assets hovered around US$4 trillion, after gradually coming down over the past two years. Then the coronavirus pandemic broke and shook health systems, economies, and financial markets worldwide. By the end of March, the Fed had taken unprecedented actions and introduced a slew of programs to keep credit flowing through the financial system, which drove its balance sheet – and the stock market – up quickly.

Over the course of two months in April and May, the Fed’s holding of assets increased to more than US$7 trillion, or more than a third of US GDP. At the same time, the S&P500 Index, a measure of the US share market, rebounded from a low of 2,237 on 23 March to of 3,232 on 8 June, its highest level since the coronavirus turmoil began.

US Federal Reserve’s total assets vs S&P500

Screen Shot 2020-07-14 at 2.03.39 pm

Source: Federal Reserve Bank of St. Louis

Since then, though, the Fed’s buying has subsided, and its balance sheet has come off from its peak. Interestingly, so too has the stock market, with the S&P500 peaking at the same time as the Fed’s assets at the beginning of June. It appears that the stock market is struggling to post further gains without the ongoing support of the Fed. This is particularly concerning as the US quarterly reporting season starts this week and more states and counties resume social restrictions after daily coronavirus case counts accelerated at the weekend.

While we own some wonderful investments in the Montaka and Montgomery Global Funds, that will provide strong compounding for decades we are also cautious about equities in the nearer term. This means that the funds remain defensively positioned today, with relatively high cash weightings, low equity market exposure, and enhanced capital protections where appropriate, in order to protect investor capital.

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Christopher is a Portfolio Manager for the Montaka funds and the Montgomery Global funds. He joined MGIM at establishment in 2015.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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